The iShares Dow Jones US Real Estate fund (IYR) gave a bear signal, and the agrotech company Monsanto Co. (MON), headquartered in Creve Coeur, Missouri, gave a bull signal.
Both pulled back toward the price channel on Friday, IYR moving back within the price channel and MON remaining outside it, although retreating toward the boundary.
The current options are the APR series of Monthlys, which trades for the last time seven days hence, on April 17.
IYR
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
Click on chart to enlarge.
 |
| IYR at 11:05 a.m. New York time, 30 days hourly bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 80.57 | 82.37 | 80.89 |
| Lower | 76.95 | 75.15 | 77.99 |
| Gain/loss | 2.3% | 4.6% |
The Trade
IYR has only a 25% success rate for bull signals over the past year. It has completed four bull signals. Three were failurs, with an average loss of -2.8% each.
I've constructed the trade to cover all but 7 cents of the upside of the one standard deviation range and all but 1 cent of the downside of the chart range. Even with that, the best risk/reward ratio I can get is a 3:1 risk/reward ratio.
short the $78 puts and long the $77 puts
sold for a credit and expiring April 18
Probability of expiring out-of-the-money
| APR | Strike | OTC |
|---|---|---|
| Upper | 80.5 | 87.3% |
| Lower | 78 | 65.3% |
Dropping the upper boundary of the profit zone down to 79.5 halves the risk/reward ratio to 3:2, which is acceptable. However, the lower risk comes at the cost of leaving $1.07 of the one standard deviation upside beyond the zone of profit, and $1.89 of the upside of the chart range. The probability of expiring out of the money is good, at 70% plus change, but the theoretical construct doesn't match the ground truth on the chart.
short the $78 puts and long the $77 puts
sold for a credit and expiring April 18
Probability of expiring out-of-the-money
| APR | Strike | OTM |
|---|---|---|
| Upper | 79.5 | 70.4% |
| Lower | 78 | 65.3% |
An alternate, weaker upside resistance level on the chart, at $79.67, argues more strongly in favor of the second construction of the trade, with a $79.50 to $78.00 profit zone.
The second proposed trade produces a profit zone that is 3.4 times the average daily price movement, or average true range.
MON
Ranges
Click on chart to enlarge.
 |
| MON at 11:45 a.m. New York time, 90 days 2-hour bars |
The upper boundary of the chart range is problematic. Often there is a correlation between the one standard deviation range and the chart range. However, in this case, the nearest chart resistance is quite week, a mere pause at $121.64 in the course of a downtrend. An alternate resistance level, $122.95, is much stronger, representing a true reversal point. However, it happened in late December and so smells like an aged Limburger cheese.
I've chosen to use the weaker, yet nearer in time, resistance level in my analysis.
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 122.32 | 125.35 | 121.64 |
| Lower | 116.26 | 113.23 | 111.16 |
| Gain/loss | 2.5% | 5.1% |
The Trade
MON has 14.3% success rate for bull signals over the past year. Out of seven completed signals, six were failures, with an average loff of -3.4% each.
There is an upward bias to the price, and so I've chosen to give up some of the profit zone on the downside, while providing full coverage of the chart range and all but 32 cents coverage of the one standard deviation range on the upside.
short the $118 puts and long the $117 puts
sold for a credit and expiring April 18
Probability of expiring out-of-the-money
| APR | Strike | OTM |
|---|---|---|
| Upper | 122 | 87.8% |
| Lower | 118 | 69.6 |
Even with that amount of give, the risk/reward ratio stands at 4:1, higher than I'm willing to accept in an iron condor position. The profit zone is 2.2 times the average daily price movement.
Decision for My Account
I'm declining IYR because of the narrowness of the profit zone that I can obtain with an acceptable degree of risk.
I'm also declining the MON trade because of my inability to obtain a reasonable zone of profit for an acceptable risk.
-- Tim Bovee, Portland, Oregon, April 10, 2015
References
My volatility trading rules can be read here.
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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
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Based on a work at www.timbovee.com.
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