Monday, July 18, 2016

IBM Analysis

Update 7/21/2016: IBM reached my minimum profit target, 50% of the maximum, and I exited what proved to be a very brief position.

Shares rose by 0.4% over three days, or a +49% annual rate. The options position produced a 100.0% yield on debit for a +12,167% annual rate.

The information technology company International Business Machines Corp. (IBM), headquartered in Armonk, New York, publishes earnings on Monday after the closing bell.

[IBM in Wikipedia]


I shall use the AUG series of options, which trades for the last time 32 days hence, on Aug. 19.


Implied volatility stands at 25%, which is 2.1 times the VIX, a measure of volatility of the S&P 500 index. IBM’s volatility stands in the 51st percentile of its annual range. The price used for analysis was 158.95.

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

Misbehaving: The Making of Behavioral Economics
by Richard H. Thaler

The Trade

IBM hit a peak on the 20-year chart in March 2013 and then began a zig-zag to the downside. At that broad level there is ambiguity in the chart, making it impossible to say based on Elliott wave analysis whether IBM began a corrective downtrend from that point as part of a continuing uptrend, or rather initiated an impulse wave to the downside.

The price hit a lowest low so far in its decline on Feb. 11 as the 5th wave to the downside. That would be compatible with the terminus of an A-wave correction or of the first of five waves to the downside at that higher degree. Time will tell.

The rise from that February low point counts as two waves and possibly the beginning of a third. The first wave, rapidly rising, has retraced a Fibonacci 78.6% of the final wave of the proceeding decline and is heading toward a 50% retracement of the entire decline from 2013. The second wave is a sideways movement.

The form of the rose since February looks to an impulse wave to me, making it most likely a wave 2 of a downtrending 5-wave impulse pattern.

IBM's price has closed higher only once on the first trading day after earnings were published.

Brokerages in aggregate give IBM a negative 33% enthusiasm index -- that low a reading could surely count as a loathing index -- with 28% of 18 analysts issuing strong buy recommendations.

The Street confirms the broader downtrend, yet the chart creates sufficient ambiguity to make me suspicious of a directional trade. I'll use a non-directional strategy.

The options grid is tricky to work with. Although strike prices are $1 apart, the strikes having open interest tend to be $5 and $2.50 apart. Although the grid looks quite granular, it is not.

Given that reality, I've had to narrow the profit range on the iron condor, like this:

Iron condor, short the $165 calls and long the $170 calls,
short the $150 puts and long the $145 puts,
sold for a credit and expiring Aug. 20.
Probability of expiring out-of-the-money


Normally my preference is for odds of expiring out of the money of 80-85%. Yet, this narrower construction covers nearly all of the central tendency of post-earnings movements over the past year. (The central tendency is calculated by discarding the maximum and minimum movements following the last four earnings announcements, and then averaging the remaining two.)

The premium is $1.82, which is 36% of the width of the position’s wings. The stock at the time of entry was priced at $159.55.

The risk/reward ratio is 1.7:1.

The zone of profit in the proposed trade covers a $7.50 move either way. The biggest immediate move after each of the past four earnings announcements was $8.58, and the average was $6.61. After eliminating the maximum and minimum post-earnings movements, the central tendency is $7.39.

Decision for My Account

I have entered a position on IBM as described above.

-- Tim Bovee, Portland, Oregon, July 18, 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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