In the Prospects list that I post each day (such as today's "Friday's Prospects", I screen for symbols that have good historical odds of making a profit after a trading signal. For this study, I'm turning that method on its head, selecting potential trades from among those with the worst odds of success.
For direction neutral trades, such as iron condors, that makes sense. By definition, a failed signal means that the price moved back in the opposite direction in what amounts to a sideways move.
Today I'll analyze HD, which dropped below its 20-day price channel on Thursday and reversed sharply to the upside the next day, failing confirmation.
When it comes to bear signals HD has to count as a big loser: Four signals in the past year, none of them profitable. That makes it a perfect candidate for a direction neutral iron condor position.
HD has Weeklys among its options inventories, and I shall use the APR1 series of options, which trades for the last time on April 3, six days hence.
HD - paper trade
The goal of my paper 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.
Range
Click on chart to enlarge.
 |
| HD at 1:30 p.m. New York time, 30 days hourly bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 116.88 | 119.97 | 117.99 |
| Lower | 110.70 | 107.61 | 111.58 |
| Gain/loss | 2.7% | 5.4% |
The Trade
Given the trend on the chart, I'm aiming for an iron condor the covers the chart range.
short the $111 puts and long the $109 puts
sold for a credit and expiring April 8
Probability of expiring out-of-the-money
| FEB | Strike | % |
|---|---|---|
| Upper | 115 | 66.8 |
| Lower | 111 | 81.7 |
The structure above assumes that the downward momentum that triggered the bear signal is exhausted. Another approach would be to hedge against that assumption being wrong by lowering the short put to 110 or perhaps even 109. However, I judge that that course would increase the risk/reward ratio unacceptably.
The risk/reward ratio on the trade as I built it stands at 2:1. The premium is 63 cents (33 cents on calls and 30 cents on puts) with shares going at $113.90.
Decision for My Account
Implied volatility is on the low side, not even double the VIX. This cuts into the premium The best coverage I could get to the upside leaves $1.25 of the top part of the one standard deviation range outside the zone of profit. There is no resistance point at that level on the chart.
On the other hand, there's a 67% chance of expiring profitably to the upside, and an overwhelming 82% chance to the downside, which are good odds either way.
This is a paper trade for research. No cash is at risk. If I were considering a trade for money, I would take this one if HD reversed course intra-day and dropped a bit, signifying that the reversal from the bear signal has lost momentum.
-- Tim Bovee, Portland, Oregon, March 27, 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.
Alerts
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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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