Volatility Trader Blog

So, last night at the close DIS reported earnings.  Initially AH the stock was up but as of right now, DIS is trading down 2.75% at $34.32

As you can see from my previous post (Click here) I was looking for a big move up or down to profit from this trade. 

We didn’t get the move I was looking for, however, I’m about breaking even and actually up a few bucks (enough to cover commissions at least).  Why did this trade work even if the underlying did not make the desired move?  (Rhetorical question).  My prediction of IV was correct.  August lost mostly all of its extrinsic value and Sep did not. 

You can see in the LiveVol Pro skew tab below how the Aug IV (red line) dropped back down to the same level as the back months. (click any picture to enlarge)

Below is the Thinkorswim analyze tab at the current price:

You can see the current P&L (white line) is almost all above the breakeven line due to the IV drop. 

At this point I’m thinking of exiting all or half at breakeven.  With less than an hour to trade today, I’m going to watch for a late day sell off.  I’ll likely exit if we get it or not.

I’ll keep you posted.  Thanks for reading! Lawrence

As I last posted (click here) on MCK the day after reporting when I closed three 3:2 spreads for $1.00 debit after initially getting a credit of $2.37 when putting them on.

I said that I was in no rush to take off the remaining spreads as they had become positive theta when the underlying moved down.

I’ve been patiently holding them with orders open to take off small positions at a time.  With time passing and MCK down a bit more, so far today two more 3:2 spreads have executed and closed for debits of $0.78 and $0.62. 

I still have four spreads open with orders to get out of them at $0.45 and $0.36.  I may move those orders up and get out of this trade by the end of the day today.  So far profit on this trade is $1768 including both open and closed positions.

The remaining contracts look like the Thinkorswim analyze tab below. As you can see there’s little profit potential left so I’ll look to be out by day’s end today. (click any picture to enlarge)

Yesterday, just before the close, I put on a trade in DIS.  They are set to report earnings today after market close. I put on a ratio diagonal spread.  I am going to walk you through my thought logic in picking this trade.

My first stop is the Live Vol Pro (www.livevol.com) software Calendar tab. I look at all the earnings for the desired date.  I then pick liquid names that are usually trading above $25 per share.  (click any picture to enlarge)

Then I look at these symbols in the Skew tab looking for horizontal and vertical skew. 

Next, I move to the Charts tab and look at the six month plot of 30 and 60 day implied volatility.

And finally, I look at the previous earnings periods moves and responses of IV and the prices of the front and back month straddles in the “Earnings and Divis” tab to get a feel for how this underlying responds to earnings historically.

In the case of DIS I see that there are both horizontal and vertical skew.  I see that both 30 and 60 day IV are not that elevated compared to previous six months IV and especially not high compared to historic earnings announcements.

Putting all this together I will then pick which trade to put on.  I almost always use term structure when trading earnings, selling high IV near term options and hedging with back month options.  When you trade calendars and diagonals one of your big risks is IV collapse of your long options along with your short options.  In this case, I don’t see much Vol crush happening to my long back month options as they are low relative to historic IV.  With only 11 days remaining in the front month Aug options, they will experience some Vol crush as IV goes to zero at expiration.

So, at this point I look at the skew tab and get an idea of where I want to be short and long.  I want to sell overpriced lower strike Aug options and buy higher strike Sep options taking advantage of Horizontal (month to month) skew and Vertical (strike to strike) skew. 

In this case I changed my strategy slightly by buying a higher strike than I sold but I am  still buying lower IV than selling. I put on half of a position yesterday and will put on the other half today.  If the underlying moves in the desired direction I’m happy as I have a small win already, and if the underlying moves in the opposite direction, I’m happy as I get a better fill price for my second half.  It’s a win-win situation, rare in trading.  Here’s the trade:

(Half position) Long twenty Sep $35 puts, Short ten Aug $38 puts for  a credit of $0.56 per 1:2 spread.

The P&L chart looks like this:

As you can see, I’m looking for a significant move in DIS, preferably to the downside.  Historically DIS gaps after earnings enough to move past my breakeven points, especially when it’s to the downside which is where my biggest profits will come.  Using the Thinkorswim analyze tab I model this with dropping the Aug IV by 5% and Sep by 2%.  This puts my breakeven points $33.78 and $36.20. Dis closed at $35.16 so there’s not that much of move needed.  This is a defined risk trade.  My max loss would never occur because I’m not going to hold my Sep options until they expire, but the max loss would be around $2,400 if the Sep options IV went to zero which will never happen.  With my above prediction of IV the max loss, if Dis moves nowhere, is around $300-$500.

Double these numbers for when I put on the remaining half today.

Plotting the breakeven points against the daily chart in Thinkorswim looks like this:

Exit strategy: Since this is a defined low risk trade I’m not in any hurry to get out, but it is a negative theta trade so time is working against me.  If there is a gap opening I’ll take my profit of at least half the position immediately and then watch the remaining for a big move in Dis after earnings. 

As always, I’ll keep you posted.

Comments are encouraged and appreciated.  Thanks for reading!  Lawrence

Friday morning MCK announced earnings that drove the stock way down.  I was in surgery at the market open so I was not in front of my screens.  When I finished my surgery around 10am EST I noticed that MCK was down but trending up.  I put in an order to sell three 3/2 spreads (-9, +6 contracts) at $1.00 debit.  It had been down as low as $0.57 earlier, but it was trending up a lot as you can see in the below chart (click any picture to enlarge).

At 10:30am MCK moved down to a low of $60.96 and my order executed.  My subsequent orders at $0.80, $0.65 and $0.50 never executed as MCK rose the rest of the day and the orders expired.  This morning I’m holding the rest and watching.  I’m now in a good theta positive place as you can see in the below analyze tab.  If MCK moves up I will get out of the rest at around breakeven for the remaining contracts keeping a small profit from the first contracts removed. Only major problem will be if MCK rallies very quickly or in the afterhours session.

(Click here to see the prior post with the Earnings trade or just scroll down)

So, MCK had a pretty volatile day.  It was up pretty big in the AM which allowed me an excellent entry point.  Originally, last night when I found this trade the credit for the spread was $2.37.  With the AM spike I was able to get $2.70 per 3/2 spread.  See chart below: (Click any picture to enlarge)

Around 14:00 EST I was up $538 and put in an order to take off 2 spreads (6/4 contracts) but it didn’t fill.  Then MCK went up and is still up as I write (15:55) and you can see in the above chart. Looks like I’m holding the whole thing into tomorrow AM earnings.

As you can see from the Analyze tab below I’m looking for the underlying to go down but staying the same or a very small increase in price will be good too.  A large rally will produce losses but that should also converge IV and I’ll lose less.

I’ll keep you posted.

Lawrence