Wednesday, March 25, 2015

TWTR: Iron condor, volatility rules

Update 3/31/2015: As expiration neared, TWTR began to edge above the profitable zone of its iron condor and I closed the position for a small profit. The decision was rushed somewhat because Friday, April 3, is a market holiday.

The stock rose by +0.6% over the six-day lifespan of the position, or a +36% annual rate. The iron condor position produced a 19.2% yield on debit, for a +1,167% annual rate.

The social media service Twitter Inc. (TWTR), headquartered in San Francisco, California, broke above its 20-day price channel on Tuesday and confirmed the bull signal on Wednesday by continuing to trade above the channel boundary.

However, intra-day momentum was to the downside, suggesting that the signal is part of a whipsaw rather than an uptrend.

Under my price channel rules that reversal would be grounds for rejecting a trade in TWTR. I've been engaged in a project for several weeks looking at another approach, and this may be an opportunity to try that approach as a real trade, rather than as a paper trade.

I've written about the project and some preliminary insights in two posts: "Expanding the volatility strategy" and "Volatility: Defining high", as well as in several analysis with the logo "Paper Trade:" in the title.

Under my volatility rules as currently written, I open positions right before earnings are published. TWTR's earnings aren't out until April 29, so there is no event to trigger a sudden change in price or volatility.

TWTR has Weeklys among its options inventories, and I shall use the APR1 series of options, which trades for the last time on April 3,  eight days hence.

[TWTR in Wikipedia]


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.


Click on chart to enlarge.
TWTR at 11:30 a.m. New York time, 30 days hourly bars
Implied volatility stands at 42%. Calculated one way, it is at the top of the most recent rise. However, a slightly broader view, looking back to early February, it is in the 16th percentile of a recovery from a collapse that brought volatility down from 71% to present levels.

In more absolute terms, TWTR's implied volatility is three times the VIX, which measures volatility on the S&P 500, a fairly high level.

Ranges implied by options and the chart
WeekSD1 68.2%SD2 95%Chart
Implied volatility 1 and 2 standard deviations; chart support and resistance

The Trade

The chart range is significantly narrower than the one standard deviation range. Covering the 1SD range with $55 short calls and $47 short puts would require placing the short calls at a level with an 85% of expiring out of the money. At that level, the risk/reward ratio is too high for my liking.

Since the price is falling, I'll narrow things from the top and introduce some downward skewing, running at $52 for the calls and keeping the puts at $47. That produces a 3:1 risk/reward ratio, still too high.

The only way to make it work will be to reduce coverage to the chart, leaving portions at both sides of the 1SD range out of the zone of profitability:

Iron condor short the $51 calls and long the $53 calls,
short the $48 puts and long the $47 puts
sold for a credit and expiring April 8
Probability of expiring out-of-the-money


The risk/reward ratio stands at 1.7:1. The premium is 73 cents (61 cents on the calls and 12 cents on the puts).

Decision for My Account

I've opened a position in TWTR as described above.

-- Tim Bovee, Portland, Oregon, Feb.. 00, 2015


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.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

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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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.

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