The stock declined by 4.3% over the 12-day lifespan of the paper position, or a -132% annual rate. The options upon expiration triggered purchase of shares. In my hypothetical scenario, I immediately turn around and sell them, although practically speaking that won't be possible until the following Monday.
The options and assigned shares produced a -0.5% loss on debit, for a -15% annual rate.
The last two trading days before expiration, the stock moved below the range of profitability inherent in the structure of my iron condor. It was quite a sudden movement, and it is unlikely that I would have been able to exit for a profit, even if it had been an actively managed real trade, with money at risk, rather than a paper trade.
This analysis for a paper trade, with no money at risk, continues my study into how to apply my volatility rules to a broader range of market situations.
See "Testing: Expanding the volatility strategy" for a discussion of the problem.
At this point I'm looking at non-trending symbols with no known major events in the near future that have implied volatility at a multiple of the S&P 500's. See "Volatility: Defining high" for a discussion of ways to assess the level of implied volatility.
Today I went to my list of liquid symbols having implied volatility around double the VIX. The later is implied volatility on the S&P 500. I framed the chart with Bollinger bands to search out non-trending symbols. I looked for bands that are generally trending sideways and not narrowing, with the current pride standing around the middle of the range defined by the bands.
This analysis looks at GM, which meets those criteria.
GM has Weeklys among its options inventories, and I shall trade the APR1 series of options, which trades for the last time on April 3, nine days hence.
One difficulty in choosing potential trades using this strategy is that earnings season begins April 8, so most large-cap companies are coming within the month when brokerage analysts pontificate and major traders adjust their positions in anticipation of the financial results and guidance, increasing the chance of sudden movements.
GM - paper trade
The goal of my trade is to construct a direction-neutral position with a zone of profitability at expiration covering all of the one standard deviation range implied by volatility and options pricing, or the 30-day hourly chart support and resistance range, whichever is wider.
Ranges
Implied volatility stands at 22%, at 2.2 times the VIX, which measures the volatility of the S&P 500. GM's volatility stands in the 5th percentile of the most recent rise.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 39.38 | 40.69 | 38.99 |
| Lower | 36.76 | 35.45 | 36.73 |
| Gain/loss | 2.0% | 4.0% |
The Trade
I attempted to build a position out of the MAR4 series, which trades for the last time on March 17, three days hence. However, I was unable to cover the one standard deviation range or come close to the chart range with sufficient premium to get a decent risk/reward ratio.
So I turned to the APR1 series.
The most recent movement on the chart is to the downside so I shall skew my position in that direction.
Covering the entirety of the one standard deviation range produced a 4:1 risk/reward ratio, larger than I like. The most recent movement on the chart is to the downside so to improve the ratio, I skewed my position in that direction, trimming the zone of profitability from the top.
The resulting proposed position leaves 56 cents of the top of the one standard deviation range outside of the profitable zone, and 17 cents of the chart range.
short the $37 puts and long the $36 puts
sold for a credit and expiring April 4
Probability of expiring out-of-the-money
| APR1 | Strike | % |
|---|---|---|
| Upper | 38.5 | 61.2 |
| Lower | 37 | 79.7 |
The risk/reward ratio stands at 2:1. The premium is 32 cents (25 cents net on the calls and 7 cents ont the puts) with shares going for $38.15.
Decision for My Account
This is a paper trade. No money is at risk. I'll add it to my inventory of paper trades. However, the narrowness of the range is a concern. I would be very nervous about this trade if I had money on the table.
-- Tim Bovee, Portland, Oregon, March 24, 2015
References
My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".
The directional score is calculated as the sum of the following:
- Zacks rating --The Zacks ratings are translated as follows: 1=2, 2=1, 3=0, 4=-1 and 5=-2.
- Enthusiasm rating --: A single percentage derived from the number of analysts whose opinions are in one of five categories: Strong buy, buy, hold, sell and strong sell.
- Strong buy share -- The percentage of all analysts who rank the stock strong buy. If the share is 60% or greater, the score is 1; if 40% or less, then the score is -1; otherwise, the score is zero.
- Ethusiasm momentum -- The score is 1 if today’s enthusiasm rating is larger than the rating 30 days earlier; otherwise, the score is zero.
- 30-day direction -- The trend that best describes the 30-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.
- One-day direction -- The trend that best describes the one-day chart: 1 for an uptrend, -1 for a downtrend and zero for a sideways trend.
Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.
Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.
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Disclaimer
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.License
All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
Based on a work at www.timbovee.com.
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