[HD in Wikipedia]
HD
I shall use the DEC series of options, which trades for the last time 32 days hence, on Dec. 18.
Ranges
Implied volatility stands at 32%, which is 1.6 times the VIX, a measure of volatility of the S&P 500 index. HD’s volatility stands in the 80th percentile of its annual range.
| Week | SD1 68.2% | SD2 95% | Earns |
|---|---|---|---|
| Upper | 130.63 | 142.03 | 123.69 |
| Lower | 107.81 | 96.41 | 114.75 |
| Gain/loss | 9.6% | 19.1% |
The biggest immediate move after each of the past four earnings announcements was $4.47, and the average was $2.60.
The Trade
HD was been in an uptrend until a downward reversal week ago, and indeed may still be. The present price decline has not yet pierced major support.
I use freely available information from Zacks Investment Research in helping to determine the directional strategy of my trades. Zacks Rank is somewhat bullish at 2, and Zacks has no expectation of an earnings surprise.
My analyst enthusiasm index stands at 5.6%, bullish but not overly so. Earnings announcements over the past year have been as likely to fall as to rise.
I shall structure my trade as direction agnostic, with a tilt toward the upside if the options grid will allow it.
And it is a difficult grid to work with. Strike prices are $5 apart -- low granularity -- and on the call side there is no strike with percentage odds in the 80s of expiring for maximum profit.
Proposed Trade #1:
short the $110 puts and long the $105 puts,
sold for a credit and expiring Dec. 19.
Probability of expiring out-of-the-money
| DEC | Strike | OTM |
|---|---|---|
| Upper | 130 | 91.1% |
| Lower | 110 | 77.3% |
The premium is $0.88, which is 35% of the width of the position’s wings. The stock was priced at $119.22.
The risk/reward ratio is 4.6:1.
The zone of profit in the proposed trade covers a $10 move either way.
That's a high risk/reward ratio and the premium seems low for such a high-priced stock. I shall try lowering the upper strike and see what the numbers tell me.
Proposed Trade #2:
short the $110 puts and long the $105 puts,
sold for a credit and expiring Dec. 19.
Probability of expiring out-of-the-money
| DEC | Strike | OTM |
|---|---|---|
| Upper | 125 | 76.6% |
| Lower | 110 | 77.3% |
The premium is $1.53, which is 61% of the width of the position’s wings. The stock was priced at $119.13.
The risk/reward ratio is 1.3:1.
The zone of profit in the proposed trade covers a $7.50 move either way.
Decision for My Account
Both proposed trades give good coverage of the range of the next-day post-earnings moves of the past year. That implies that the market is pricing in abnormally low odds of options expiring out of the money for maximum profit. In others words, the market is expecting an unusually high move.
It's an anomaly, and one that I'm unable to resolve on this grid in a direction-neutral fashion. I'm passing on HD and shall not place a trade.
-- Tim Bovee, Portland, Oregon, Nov. 16, 2015
References
Tradecraft: Playing the odds to build winning stock market trades from options, a description of how I trade, can be read here.
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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