Wednesday, July 22, 2015

LUV Analysis

Update 8/1/2015: The LUV calls and puts both expired without value.

Shares rose by 4.4% over 10 days, or a +159% annual rate. The position produced a 100% yield on debit, for a +1,000% annual rate.

The low-cost air carrier, Southwest Airlines Co. (LUV), headquartered in Dallas, Texas, publishes earnings on Thursday before the opening bell.

[LUV in Wikipedia]



Click on chart to enlarge.
LUV at 10:20 a.m. New York time, 30 days hourly bars
Implied volatility stands at 37.4%, which is 3.1 times the VIX, a measure of volatility of the S&P 500 index. LUV’s volatility stands in the 87th percentile of its most recent rise.

Ranges implied by options and the chart
WeekSD1 68.2%SD2 95%ChartEarns
Implied volatility 1 and 2 standard deviations; chart support and resistance, maximum earns move

The Trade

I shall use the JUL5 weekly series of options, which trades for the last time nine days hence, on July 31.

The maximum post-earnings movement is quite large compared to the average movement. The latter produces a range of from $36.12 down to $33.12, not far from the one standard deviation range.

The maximum range is so far out that the options lack liquidity, so I shall be aiming toward placing the narrower one standard deviation range within the profit zone.

The stock price is uptrending, so I'll compromise at the lower side of the range if such becomes necessary.

Iron condor, short the $37 calls and long the $38 calls,
short the $34 puts and long the $33 puts,
sold for a credit and expiring Aug. 1.
Probability of expiring out-of-the-money

The premium is $0.29, which is nearly a third of the width of the position’s wings.The stock at the time of purchase was priced at $34.60.

The risk/reward ratio is 2.3:1.

The zone of profit in the proposed trade covers a $1.50 move either way. The biggest immediate move after each of the past four earnings announcements was $3.52, and the average was $1.27.

Decision for My Account

It required quite a large compromise to get sufficient premium. The proposed trade above leaves $1.80 of the one standard deviation range outside of the zone of profit. True, the fudge is on the lower side, and the stock is uptrending. Yet, the range covered is beyond the average move after an earnings announcement, which mitigates the risk considerably.

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

-- Tim Bovee, Portland, Oregon, July 22, 2015


My volatility trading rules can be read here.


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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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