IBM Analysis

International Business Machines Corp. (IBM)

Note: This trade was based on a hypothetical study aimed at allowing hedged trading of earnings announcements. To ensure I had an accurate fill price, I converted the hypothetical high-risk portion of the hedge to an actual trade, which I placed on Wednesday.

Update 7/18/2019As my experimental rules require, I have exited my short iron fly earnings play on IBM. As the closing bell approaches, it is trading beyond its zone of profitability. The implied volatility rank declined by 11 points to 42%.

IBM published earnings on July 17, swung wildly in the overnight trading, and then, after opening within the profit zone, swiftly rose to above the zone. The way I structured the trade, my maximum loss was $81 per contract. I got out for a $3.92 debit, producing a $79 loss per contract, $2 below the max. Shares at the exit were trading at $149.34, up $6.82 from their entry level.

Shares rose by 4.8% over one day, or a +1,747% annual rate. The options position produced a -20.2% loss for a -7,356% annual rate.

Update 7/18/2019IBM published earnings after the closing bell on July 17, beating the street estimate by 9.2 cents for a quarterly result of $3.17 per share. The market had closed pre-earnings at $143, the short strike price of my iron fly. After the earnings announcement, the price almost instantly rose in after-hours trading to $149, quickly fell to $140.34, and then bounced, settling between $141 and $142. After the opening bell the price rose sharply again and as of 9:55 a.m. New York time was trading at $147.53, a dollar above the profit zone. The implied volatility rank stands more than three points of where it was before earnings.

As set out in the hypothetical study, the idea was for this high-risk trade to be paired with a low-risk trade expiring on August 16. The low-risk position, described in the hypothetical study, has a profit range running from $150.88 to $120.88 and had I made such a trade, would remain profitable with quite a large margin to spare.


On July 17 I 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 $142.13 on the downside.

The implied volatility rank (IVR) stands at 53.

IBM publishes earnings after the closing bell the day of entry into the position.

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 142.13 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, with a maximum risk of $81 per contract and a maximum reward of $313 per contract.

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

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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

I made the high-risk short iron fly trade described below and have exited for a loss. See IBM Analysis for details.


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, 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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