Live: Thursday, July 18, 2019

3:35 p.m. New York time

GDXJ results posted.

3:20 p.m. New York time

GDXJ has moved above its profit zone, with the rate of change placing it more than a day beyond recovery. Following the dictates of my rules, I have exited for a $0.97 debit. Results upcoming.

1:40 p.m. New York time

I exited IBM for a loss and have updated the analysis with results.

10 a.m New York time

I’ve posted my analysis of the short iron fly position on IBM.

9:45 a.m. New York time

I have placed exit orders on KRE and XBI, as they continue to hover around 50% of maximum potential profit. This has been going on for several days, without fills at my bidding price.

IBM published earnings last night. I shall post an analysis shortly.

By Tim Bovee, Portland, Oregon, July 18, 2019

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Thought Experiment: An IBM earnings play

Post-Final Update 8/2/2019: And the day after my paper exit, the market saw a significant decline, making the on-paper short iron condor on IBM profitable, at 14.8% of maximum potential profit. The on-paper price I’m using today is a 75 cent debit to exit, with shares trading for $146.62.

Interesting post-outcome. IBM proved to be an outlier on these trades, over and again. And the market itself, in the opening days of August, has proven to be stubborn mule with a mind not likely to listen to my expectations, or anyone else’s, for that matter.

Final Results 8/1/2019: My short iron condor paper trade on IBM, part of a thought experiment in hedging earnings plays, gave an exit signal today, ending the experiment.

It had two parts: One a short iron condor with a high probability of success, which I entered on paper on July 2, and a short iron fly with a lower probability of success, which I did as an actual trade on July 18. See IBM Analysis for details of the short-iron fly trade. The iron condor analysis is below.

The short iron condor position moved beyond the upper boundary of the profit zone, with a rate of change that meant it would take more than a day, at that rate, to return to the zone. Under my rules, with 15 days left until expiration, I was required to exit.

On paper, I exited IBM for $2.38, a $-150 loss per contract on the options, with shares trading for $151.88, or $11.66 above the entry price.

IBM rose sharply after earnings were announced, and rose sharply again today — two stormy punctuations amid a sideways flow.

Shares rose by 8.3% over 30 days, or a +101% annual rate. The options positions produced a 63.0% loss for a -767% annual rate.

Conclusion:

This was about as close to a disaster as this method could have produced.: a 63.0% loss on the iron condor and a 20.2% loss on the iron fly. Had I just done the earnings play alone, the percentage loss would have been a quarter of the combined total. 

This is a sample size of one. Means nothing in itself. However, based on my experience with this trade, the results exceeded my worst nightmares. The risk estimates going into this experiment were based on the extremes: 100% losses and 100% wins. The interim results — read “actual results” — were more extreme.

I’ll continue to look at the question of how best to trade earnings announcements, but I’m not willing to jump in again without further study.


Last week I mused in an essay on how to expand the range of my high probability of success strategy by holding positions through an earnings announcement. The problem has always been that earnings announcements are by their very nature prone to surprises, and a surprise can take a wide iron condor, with 85% probabilities of success in either direction, and instantly turn it into a loser.

The strategy for trading earnings that I described is the polar opposite of my high probability strategy, which is longer-term, low report, low risk. In contrast, the earnings play strategy is short term, high reward, high risk.

The question is, can they work together, allowing me to hold iron condors on stocks through their earnings announcements.

IBM publishes earnings next Wednesday, July 17, after the closing bell. To get a better sense of how the two strategies interact, I’ve constructed two hypothetical trades. The first is a high probability trade, a paper trade using the August monthly options expiring Aug. 16 and entered 45 days before expiration. The second is a low probability earnings play using the July monthly options expiring July 19, two days after I enter the position.

Here’s what the analysis looks long for the longer-term trade with a higher probability of success:


International Business Machines Corp. (IBM)

I have, as a paper trade, on July 2 entered a short iron condor spread on IBM, using options that trade for the last time 45 days hence, on August 16. The premium is a $0.88 credit and the stock at the time of entry was priced at $140.22.

The profit zone for this position is between $150.88 on the upside and $120.88 on the downside.

The implied volatility rank (IVR) stands at (an estimated) 54%.

Paper Premium: $0.88 Expire OTM
IBM-iron condor Strike Odds Delta
Long 155.00 94.0% 6
Break-even 150.88 90.0% 11
Short 150.00 86.0% 16
Puts
Short 125.00 86.0% 12
Break-even 120.88 88.5% 9.5
Long 120.00 91.0% 7

The premium is 17.6% of the width of the position’s wings.

The risk/reward ratio is 4.7:1.

The hypothetical date of entry was July 2.


This is fairly typical of any of the high probability positions that I’ve been entering. A key metric to note is the risk/reward ratio. In this hypothetical trade, the most return I can gain is $88. The most I can lose is $412. That’s the price of setting the short-leg strike prices so far apart, and is why I’m reluctant to hold high probability low reward trades on stocks through an earnings announcement.

In this hypothetical exercise, on the trading day before the earnings announcement, I’m going to add in a second position, also an iron condor but sometimes called an “iron fly” to distinguish the two. While the short-leg strikes on most iron condors are different, they are in an iron fly the same.

For the iron fly, I’m entering the paper trade two days before expiration, on July 17, using the July monthlies expiring July 19. If the iron fly is profitable after the announcement, then I’ll let the position expire. If it is unprofitable, then I’ll attempt to exit on July 18 in order to reduce my loss.

The hypothetical iron fly analysis looks like this:


International Business Machines Corp. (IBM)

I have hypothetically entered a short iron fly spread on IBM, using options that trade for the last time two days hence, on July 19.

The premium is a $3.13 credit and the stock at the time of entry was priced at $142.52.

The profit zone for this position is between $146.13 on the upside and $142.19 on the downside.

The implied volatility rank (IVR) stands at 53.

Premium: $3.13 Expire OTM
IBM-iron fly Strike Odds Delta
Long 147.00 69.1% 33
Break-even 146.13 59.6% 42.8
Short 143.00 50.0% 52.6
Puts
Short 143.00 50.0% 47.4
Break-even 142.19 59.0% 38.7
Long 139.00 67.9% 30

The premium is 78.3% of the width of the position’s wings.

The risk/reward ratio is 0.3:1.

The hypothetical date of entry was July 17.


In setting up the iron fly trade, I aimed to set the long legs as close to a 30 delta as I could get. In this case that gave a reward that is nearly 10 times the risk. The return is capped at a comfortable $313 per contract, compared to a maximum loss of $87.

The result is a combined risk/reward ratio of 4.8, or a maximum loss of $499 per contract on the combined positions, and maximum win of $401 on the positions. A win/win on the two positions is more likely than a lose/lose outcome.

The lose/lose scenario adds $87 to my already considerable losses, so it’s not much in the way of additional pain.

A win on the high probability iron condor position combined with a loss on the low probability iron fly position would produce a $1 return per contract.

In the reverse, a win on the earnings play iron fly combined with a loss on the high probability iron condor produces an $99 loss, which produces a twinge of pain but falls short of a howl of agony. This is the least probable of the outcomes.

I find this to be an acceptable hedge. The most probable outcome saves me from a loss. The least probable saves me from catastrophe. And the best outcome gives a return nearly five times what I could expect from the high-probability iron condor alone. (The precise actual ratio is 3.6 times.)

It has the added advantage of giving me exposure to high volatility earnings plays while reducing the risk of such losses.

Next steps for this study:

On Thursday, July 18 (tomorrow), I’ll be looking at how the announcement impacted the price of the high-risk iron fly position. If it is in losing territory, I’ll try to exit. Otherwise, I’ll let the position expire.

On July 26 I’ll apply my normal non-earnings rules to the low-risk iron condor position and exit if there is any profit, no matter how low. If it’s not profitable, then I’ll continue to hold under the the sudden-death rules.

By Tim Bovee, Portland, Oregon, July 17, 2019

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Live: Wednesday, July 17, 2019

4:30 p.m. New York time

No fill on KRE and XBI.

11:05 a.m. New York time

I’ve posted my study, “Thought Experiment: An IBM earnings play“.

10:05 a.m. New York time

I’ve posted results for IWM.

9:35 a.m. New York time

I’ve exited IWM for 50% of maximum potential profit, or a debit of $0.21. Full results to come.

I’ve also placed exit orders for 50% of max prof on KRE, for an $0.18 debit, and XBI, for a $0.33 debit.

By Tim Bovee, Portland, Oregon, July 17, 2019

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Live: Tuesday, July 16, 2019

4:40 p.m. New York time

No fills on today’s orders.

12 a.m. New York time

As I mention often, my trading strategy for the most part derives from work done by the team at TastyTrade, a research and education organization founded by Tom Sosnoff, a former option floor trader in Chicago.

The biggest counter-intuitive element of the TastyTrade approach their handling of theta, the decline in options prices as expiration approach. They take an early management approach, exiting trades 21 days before expiration. The conventional wisdom, and all of my teachers when I was learning about trading, say that most of the profit comes at the very end, the week of expiration.

In this segment of their program “Market Measures” from Monday, Tom and former market maker Tony Battista discuss the two approaches and why they have concluded that early management is the best practice.

I highly recommend it.

10:45 a.m. New York time

XBI is again approaching 50% of maximum potential profit, and I have placed an exit order for a $0.33 debit.

9:35 a.m. New York time

As I did yesterday, I have today placed exit orders on IWM for a $0.21 debit and KRE for an $0.18 debit, each being 50% of maximum potential profit.

By Tim Bovee, Portland, Oregon, July 16, 2019

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Live: Monday, July 15, 2019

Update 4:05 p.m.

None of today’s three exit orders was filled.

Update 2:45 p.m. New York time

XBI is trading within 6 cents of 50% of maximum potential profit, and I placed an exit order for a $0.33 debit.

Update 2:40 p.m. New York time

IWM is trading within 4 cents of 50% of maximum potential profit, and I placed an exit order for a $0.21 debit.

Update 10 a.m. New York time

KRE opened within 2 cents of attaining 50% of its maximum potential profit, and I placed an exit order for an $0.18 debit.

I’ve posted by post-mortem of my July 1 exit from NVDA and SMH. What if I had held these losing positions up to a week before expiration? “NVDA and SMH: What If?“.

By Tim Bovee, Portland, Oregon, July 15, 2019

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NVDA and SMH: What If?

On July 1 my short iron condor positions NVDA and SMH — both in the semiconductor sector — became unprofitable as a result of news reports involving the U.S. trade disputes with China.

The options were the July monthlies, expiring July 19. Under my trading rules for high probability iron condors, I manage losing trades 21 days prior to expiration. After Day 21, my sudden death rule kicks in: “Exit if the price moves beyond the range of profitability by any amount.”

And that’s what I did with NVDA and SMH. But it’s always good to test rules, so I kept the positions alive as paper trades, to see what would happen if I held the position to the Monday prior to expiration.

The answer is, not much. NVDA was trading at a $4.89 debit when I exited 15 days before expiration. A week before expiration, the paper position was trading lower, for $4.04, but was still unprofitable. SMH rose from a $2.52 debit at exit to a $3.04 debit five days before expiration and also remained unprofitable.

In other words, I would have cut my loss by $85 per contract by continuing to hold NVDA, and increased my loss by $52 per contract by continuing to hold SMH. In return, I would have tied up the funds in those positions for an additional 15 days, missing the chance to re-invest that money in the August monthly options and perhaps having enough return to offset the loss.

In this case, I would say, my sudden death rule proved to be the better course.

By Tim Bovee, Portland, Oregon, July 15, 2019

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Live: Friday, July 12, 2019

1:40 p.m. New York time

My positions are ending the week profitable, except for EWZ, which is within its profit range but not yet profitable.

Next week I have two thought experiments that I’ll be posting. These are hypothetical trades testing alternative strategies by asking, “What if—-?”

The first will come on Monday, July 15, testing what would have happened had I held NVDA and SMH until the week of expiration, rather than exiting when they became unprofitable, as my rules require. In the intervening two weeks, did they become wildly profitable, branding my early exit as a costly mistake? Of did they continue to sink in the quicksand of loss, branding my early exit as a stroke of genius? Monday’s thought experiment will provide answers.

The second will come on Wednesday, July 17, testing the strategy I wrote about in an essay earlier this week, on July 10. The strategy would allow me to hold high-probability positions through earnings announcements by entering a very short term low probability position as a hedge. IBM’s earnings announcement after the closing bell gives me an opportunity to test the idea, on paper, no dollars at risk. I’ll post the analyses of the hypothetical trades on Wednesday and then follow through with results of the earnings play on Thursday and of the long-term position whenever I exit, most likely on July 26.

By Tim Bovee, Portland, Oregon, July 12, 2019

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Trading Earnings Announcements

My sole strategy the last few months has been

  • wide iron condors (deltas of 20 or less for the two short legs)
  • and high implied volatility ranks
  • entered with about 45 days until expiration
  • and managed at 21 days before expiration
  • while avoiding earnings announcements.

Such a setup generally gives an 80%+ chance of earnings profit, always a good thing. But it limits the choice pretty much to exchange-traded funds. Because the dirty little of implied volatility is that it goes up as earning approach, and goes down quite suddenly once the earnings announcement has been made.

I think the term of art for such a situation is “stuck between a rock and hard place.” For the most part, I can’t find high implied volatility without earnings, and the surprises that come with earnings can destroy the advantage I get from trading wide and safe.

So what’s a trader to do? Here’s an approach I shall be trying.

The iron fly (a term coined by the team at the options education site TastyTradeis the narrowest of iron condors, with the two short legs having the same strike price. Whereas the wide iron condors I trade generally will have a 4:1 risk/reward ratio, an iron fly can be set up so as to reverse that to a 1:4 risk/reward ratio.

An iron fly strategy for earnings would  to trade

  • iron flys (deltas as close to 50 as possible on each of the two legs, consistent with their having identical strike prices)
  • and high implied volatility ranks
  • entered on the closest trading day to the earnings announcement
  • with about two days before expiration
  • and managed immediately after the earnings announcement or allowed to expire.

So for example, IBM publishes earnings on July 17 after the closing bell, meaning I would enter my trade on that day. The IV Rank (today) is 55.3%, which is quite high. The setup (if today were the day) is to trade options expiring July 19, short the $141 calls and puts, with the long wings $4 wide on each.

With that setup, the most I can lose per contract is $91 ($0.91 per contract/share), and I can potentially gain $324 per contract ($3.24 per contract/share). Thats a 1:3.6 risk/reward ratio.

Narrow the wings to $3 wide and the maximum is $259 per contract vs. a maximum loss of $41 (risk/reward = 1:6.3).

I’ll know before the next trading day what the outcome is, and I can decide whether to get out of a losing position a day before expiration, or let a winning position expire.

Earnings are devilishly difficult to predict. The iron fly strategy lessens the cost of being wrong to a trivial amount, and that’s what makes it attractive.

I’m still thinking about how the iron fly strategy might work with my wide iron condor strategy in order to allow me to hold wide iron condors through earnings announcements. Certainly a successful iron fly would enhance earnings from a wide iron condor. If the wide position has moved close to one of the wings, the iron fly could provide a hedge. Maybe. I still need to work that out, and I’ll post an update when I have.

By Tim Bovee, Portland, Oregon, July 10, 2019

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Live: Monday, July 8, 2019

3:45 p.m. New York time

With 39 days remaining until expiration of the August options, I anticipate that there’s little chance that any of my positions will move beyond their profit zones.

sym option debit share price curr % max profit
EWZ 0.61 45.59 (22.0)
GDXJ 0.32 34.65 11.1
IWM 0.39 155.25 7.1
IYR 0.41 90.24 4.7
KRE 0.36 53.33 2.7
XBI 0.61 85.59 7.6

At the end of the week, on Friday, I’ll revisit two losing trades with July options, NVDA and SMH, seeking to answer the question, What if I had held the positions rather complying with my trading rules and exiting?

By Tim Bovee, Portland, Oregon, July 8, 2019

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IWM Analysis

iShares Russell 2000 ETF (IWM)

Update July 17, 2019I’ve exited IWM for 50% of maximum potential profit — a $0.21 debit, 21 cents less than the credit received at entry — as shares were trading for $155.28, which is 16 cents above the price at entry.

The price basically went nowhere during the position’s lifespan. The implied volatility rank fell from 13.9% at entry to 10.4% at exit, joining with the normal theta decay of options to produce the profit.

Shares rose by 0.1% over 12 days, or a +3% annual rate. The options positions produced a 100.0% return for a +3,042% annual rate.


I have entered a short iron condor spread on IWM, using options that trade for the last time 42 days hence, on August 16. The premium is a $0.42 credit and the stock at the time of entry was priced at $155.12.

The profit zone for this position is between $163.42 on the upside and $143.42 on the downside.

The implied volatility rank (IVR) stands at 13.9%.

Premium: $0.42 Expire OTM
IWM-iron condor Strike Odds Delta
Long 165.00 91.0% 9
Break-even 163.42 88.0% 12
Short 163.00 85.0% 15
Puts
Short 145.00 85.0% 14
Break-even 143.42 87.0% 12.5
Long 143.00 89.0% 11

The premium is 21% of the width of the position’s wings.

The risk/reward ratio is 3.8:1.

By Tim Bovee, Portland, Oregon, July 5, 2019

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