Shares rose 0.2% over five days, or a +16% annual rate. The options position produced a +75.8% yield on debit, for a +5,530% annual rate.
The computer hardware manufacturer and services provider Hewlett-Packard Co. (HPQ), headquartered in Palo Alto, California, and the clothing chain The Gap Inc. (GPS), headquartered in San Francisco, California, publish earnings on Thursday after the closing bell.
I shall use the MAY5 Weeklys series of options, which trades for the last time eight days hence, on May 29.
HPQ
Ranges
Click on chart to enlarge.
 |
| HPQ at 9:50 a.m. New York time, 90 days 2-hour bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 34.85 | 36.36 | 33.74 |
| Lower | 31.91 | 30.30 | 31.00 |
| Gain/loss | 4.6% | 9.1% |
The Trade
The proposed trade covers all of the chart range within the profit zone but leaves 35 cents at the top of the one standard deviation range uncovered.
short the $31 puts and long the $30 puts
sold for a credit and expiring May 30
Probability of expiring out-of-the-money
| MAY5 | Strike | OTM |
|---|---|---|
| Upper | 34.5 | 71.2% |
| Lower | 31 | 82.1% |
The risk/reward ratio stands at 1.9:1. The premium is $0.33 ($0.24 for the calls and $0.09 for the puts).
GPS
Ranges
Click on chart to enlarge.
 |
| HPQ at 10:05 a.m. New York time, 30 days hourly bars |
| Week | SD1 68.2% | SD2 95% | Chart |
|---|---|---|---|
| Upper | 41.08 | 42.60 | 40.64 |
| Lower | 38.04 | 36.52 | 38.09 |
| Gain/loss | 3.8% | 7.7% |
The Trade
My normal starting point in constructing a trade is to place the shorts where the odds of expiring out of the money for maximum profit is between 70% and 75%. In the case of GPS, the boundary would be the 39.5 strike, at 70.8%, and lower one at the 37.5 strike, or 71.2%.
No problem with the lower boundary, but the upper boundary leaves a significant portion of the chart range and one standard deviation range in unprofitable territory. A case can be made that such a skewing is acceptable, given the downtrending nature of the chart. Still, that's a lot of trades happening in an area that would cause loss.
A structure that would cover the chart range and most of the 1SD range is this:
short the $37.5 puts and long the $0 puts
sold for a credit and expiring May 30
Probability of expiring out-of-the-money
| MAY5 | Strike | OTM |
|---|---|---|
| Upper | 41 | 91.5% |
| Lower | 37.5 | 70.5% |
The risk/reward ratio stands at 3.5:1, which is extremely high for an iron condor.
Decision for My Account
I've opened a position in HPQ as described above. I've declined to take a position in GPS because I'm unable to provide reasonable coverage of the chart and statistical ranges with sufficiently low risk in relation to reward.
-- Tim Bovee, Portland, Oregon, May 21, 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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