Tuesday, March 29, 2016

RH Analysis

Update 5/3/2016: RH moved to the top of its profitable range oafter earnings were published and stayed there ever since. I took advantage of a sudden dip deep into the range and exited at 64% of potential profit. My standard is 50% or better.

Shares rose by 4.9% over 35 days, or a 52% annual rate. The otpions position produced a 177.8% yield on debit for a +1,854% annual rate.

The home furnishings company Restoration Hardware Holdings Inc. (RH), headquartered in Corte Madera, California, publishes earnings on Tuesday after the closing bell.

[RH in Wikipedia]


I shall use the MAY series of options, which trades for the last time 52 days hence, on May 15.


Implied volatility stands at 74%, which is 4.8 times the VIX, a measure of volatility of the S&P 500 index. RH’s volatility stands at the peak of its most recent range. The price used for analysis was $38.68.

Ranges implied by options and earnings
WeekSD1 68.2%SD2 95%Earns
Implied volatility 1 and 2 standard deviations; central tendency earns move

The Trade

RH has been in a nearly unrelieved downtrend since November 2015, switching into a sideways movement on Feb. 24 that so far falls far short of signaling a trend reversal.

The stock price has closed higher twice after half of the last four earnings announcements. Changes in analyst ratings suggest a potential upside earnings surprise, although an upward move on the chart seems counter-intuitive at first glance, although the Elliott wave count of the decline doesn't rule out the possibility.

Brokerages give RH a negative 14% enthusiasm index, with 43% of 14 analysts issuing strong buy recommendations.

Heeding the earnings surprise possibility, I looked first at a directional trade.

Bull put spread, short the $35 puts and long the $30 puts,
sold for a credit and expiring May 16.
Probability of expiring out-of-the-money

The premium of $1.20 gives the position 3.2:1 risk/reward ratio, and that's the lowest ratio available for a bull put spread on this grid. That's high for a short vertical spread.

I next turn to a direction neutral strategy that may provide a more acceptable level of risk and also address my misgivings about going bullish on chart so aggressively bearish.

Iron condor, short the $45 calls and long the $50 calls,
short the $30 puts and long the $25 puts,
sold for a credit and expiring May 16.
Probability of expiring out-of-the-money

The premium is $1.25, which is 25% of the width of the position’s wings. The stock at the time of entry was priced at $38.76.

The risk/reward ratio is 3:1. This is almost the same as with the vertical spread I essayed, but for iron condors, a ratio of 3:1 is quite the norm.

Lower risk/reward ratio, significant profit on either side of the entry price -- what's not to like? I'll go with the iron condor.

The zone of profit in the proposed trade covers a $7.50 move either way, encompassing the average and core tendency for the past four announcements.

The biggest immediate move after each of the past four earnings announcements was $13.43, and the average was $6.78. After eliminating the maximum and minimum post-earnings movements, the core tendency is $6.14.

Decision for My Account

I have opened an iron condor position on RH as described above.

-- Tim Bovee, Portland, Oregon, March 29, 2016


Tradecraft: Playing the odds to build winning stock market trades from options, a description of how I trade, can be read here.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner 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


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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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Based on a work at www.timbovee.com.

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