In our efforts to find  new and different option opportunities in this world of 5-year-low SPY option prices, we have been checking out pre-earnings-announcement strategies. 

Just prior to the earnings announcement, implied volatility (IV) of the options which expire just after the announcement escalates due to the uncertainty of what the earnings, sales, margins, or guidance might be. 

We have had some success buying calendar spreads at strikes below, near, and above the stock price in advance of an earnings announcement.  These spreads have a tremendous IV advantage (the options we sell have a higher IV, making them more “expensive” than the options we buy). 

Last week, we used this strategy on Starbucks (SBUX).  When we used just the calendar spreads, we managed to make 11% after commissions by selling the spreads the day after the announcement. This was out fourth consecutive week of making pre-earnings announcement gains. 

In addition to the calendar  spreads, we also bought some extra straddles or strangles (both puts and calls) which were designed to protect the entire portfolio against a loss in case the stock moved big-time after the announcement.  This time around, with SBUX edging up about $1.50 after the announcement, the straddle-strangle protection lost money when IV for those options plummeted after the announcement, and the portfolio that used both calendars and strangles broke even for the week. 

While studying the past history of SBUX we discovered an interesting pattern which is the subject of this week’s Idea of the Week. 

Terry

 A Post-Earnings Starbucks (SBUX) Play 

Last week SBUX rose $2.00 for the week, spurred higher by a good earnings report and the company re-affirming guidance.  We checked back over the last 13 times when SBUX rose by $2.00 or more in a week and learned that in the subsequent weeks, 10 times at some point during the week, SBUX traded at least $1.00 lower. 

With SBUX trading at $56.81, I will be buying Mar-13 57.5 puts, hopefully paying about $2.19, Friday’s closing ask price.  Immediately after making this purchase I will place an order to sell those puts for $.70 higher than what I paid for them (if the stock falls by $1.00 this put option should move $.70 higher).   

If this trade executes, I should make about 30% on my money after commissions. 

If the stock starts moving higher instead of lower, I will sell some Feb1-13 57.5 puts to reduce or eliminate possible losses (but I will be careful not to sell quite as many puts as I own long ones so that if the stock does fall, I should still make a gain). 

I expect to close out the positions by the end of the week unless the stock has edged up to being very close to $57.50 in which case I might sell the next Weekly series 57,5 puts because the time premium should be quite high (and I have six more weeks over which I can continue to  sell puts at this strike so that I can get back my initial $2.19 back, and more).

The AAPL crash after the earnings announcement surely hurt a lot of people big-time (several people had commented that just buying calls was the smart way to approach the announcement, and others said they were selling out-of-the-money puts to be more “conservative” – they are the ones who got hurt the most – at least the call buyers only lost their entire investment).

 If you recall, in my Seeking Alpha article entitled A Remarkably Safe Way To Play The Apple Earni…  I recommended buying one AAPL Apr-13 500 straddle and selling one Jan4-13 500 straddle to take advantage of the huge difference in IV between them (April = 34, Jan4-13 = 76).  In addition, I said to buy two Apr-13 500 straddles to protect against a large move in AAPL in either direction. 

The difference between the first two straddles came up to $2900, and the extra two straddles cost $6500 each (I actually got better prices than these, but let’s go with the numbers I used in the article). 

I waited until Friday about noon to close out the positions.  AAPL had fallen all the way to $440, down about $60 since I placed the spreads, and $75 from where it had closed just before the announcement. 

I closed out the long and short straddles by selling both the  puts and calls as a calendar spread, collecting $570 for the calls and $750 for the puts.  So I lost money on those spreads (cost $2900, sold for $1320, lost $1580). 

The extra two straddles were sold for $7350 each ($14,700 total) compared to the $13,000 cost for a gain of $1700.  Bottom line, after paying $15 in commissions, I eked out a gain of $105 for the day. 

I consider myself lucky, especially waiting until Friday to close it out (the stock fell another $10 by the time I sold so I did better with the extra straddles than I would have done closing out on Thursday).  

I suspect that my small gain was a whole lot better than most option-players experienced this earnings week (I surely did a whole lot worse in many of my other spreads, most calendars at higher strike prices than $500 – all of which lost big time).

It ended up being one of the worst weeks ever for me, in fact. 

The biggest reason that the “remarkably safe” positions I  recommended  did not do anywhere near what the risk profile graph had suggested the spreads might gain was because IV of the April options fell far more than I expected.  Before the announcement, IV was 34, lower than any other option month.  After the announcement, IV tumbled to 29.  The at-the-money straddle would cost $4900 to buy compared to the almost $6500 that I paid for the April at-the-money straddle a couple of days earlier. 

The at-the-money Feb1-13 440 straddle with a week to go until expiration (as I write this with AAPL at $440) could be sold for $1730 or just about half what the at-the-money straddle with a week of remaining life could be been sold for prior to  the announcement. 

In conclusion, it is important not to get too excited about the risk profile graphs that get created before an earnings announcement (unless your software allows you to set an expected IV of the longer-term options). 

The inevitability of all option prices falling dramatically after the earnings announcement makes calendar and diagonal spreads difficult to execute profitably at the time.

Apple announces earnings Wednesday after the close and I have come up with a strategy that looks like it can make a decent gain for the week (ranging from 5% to 15%) with almost no chance of incurring a loss. 

The big downside of the strategy is that it requires an investment of about $16,000.  I understand that many subscribers are looking for less costly option investments.

 However, if you can afford an investment of this size, check out the Seeking Alpha article I wrote just yesterday. 

Terry 

Here is the link – A Remarkably Safe Way To Play The Apple Earnings Announcement 

This is the third week in a row that I have offered a strategy centering on the unusually-high option prices in the series that expires just after an earnings announcement. 

The first play was for Wells Fargo – How to Play the Wells Fargo Earnings Announcement for Tomorrow.  This one gained 44% after commissions. 

The second play involved eBay – How to Play the EBAY Earnings Announcement.  I waited too long to close out my spreads this time around (many subscribers gained 24% or more).  But I did manage to make 11.6% after commissions, still not a bad week. 

I think this week’s earnings-announcement play is the safest one yet in spite of the high cost  requirement.  I am also sharing with paid subscribers a most promising play in Starbucks (SBUX).

Closing Out the eBay Spreads 

All of the shot options could be purchased for $.01 (with no commissions due at thinkorswim) so I bought them all back. 

The earlier net cost I reported was inaccurate (in my note to subscribers, I recommended buying 10 of the 50 put spreads but I used 20 in the calculations).  The net investment after commissions was actually $3417.50 rather than the $3942.50 reported. 

This is what I sold the remaining Feb-13 options for (after subtracting the $.01 repurchase of the short options): 

10 Feb-13 50 puts for $.26 = $260 

20 Feb-13 52.5 puts for $.80 = $1600 

20 Feb-13 55 calls for $.90 = $1800

10 Feb-13 57.5 calls for $.23 = $230 

Commissions on sales – 60 x $1.25 = $75

Net received = $3815 

Cost = $3417.50 

Gain = $397.50, or 11.6%

While an 11.6% gain after commissions isn’t bad for a couple of days, it was far less than we expected going in.  The big disappointment came from how much implied volatility (IV) of the February options fell after earnings were announced.  I had estimated that it would fall from 35 to 33 (its number when there was a full month remaining in the January options).  Instead, IV tumbled all the way to 25 so that the February options were trading at prices much lower than we expected. 

Several subscribers have written in saying they took off the spreads on Thursday before IV had tumbled so much, and they made an average of about 24% after commissions. 

Knowing that IV will fall so much can be helpful in the future.  There are at least two things we might do differently.  First, we could buy longer-term options for the long side.  IV for the April options only fell 3 points after expiration.  While this would require a much larger investment, the net gain should be much higher. 

The other possibility would be to sell next-month iron condors just before the earnings announcement.  After the announcement, when IV for those options crashes it should be possible to close out the spread at a nice gain (not waiting until expiration).  The risk should be quite low here. 

Next week, in our Terry’s Trades portfolio, we will be placing calendar spreads in advance of the Starbucks earnings announcement on Thursday.  IV for the Weeklys we will be selling is 45 while the Feb-13 options carry an IV of 28 but the April options are only at 24 so they are likely to fall not nearly so far. 

In addition to placing the calendar spreads with April as the long side, I will personally sell an iron condor in the Feb-13 series to see how that compares to the calendar spreads.

 Of course, I will report back to let you know how each of these strategies perform.

Update on eBay Trades

With the stock up nicely today, I am taking off the put calendar spread at the 50 strike:

BTC 20 EBAY Jan-13 50 puts (EBAY1301029P50) for $.02 (no commission)

STC 20 EBAY Feb-13 50 puts (EBAY130216P50) for $.28

I plan to wait until near the end of the day tomorrow to take off the remaining spreads.

At this point, I could close out all the positions and make a gain of about 25% after commissions.  This was a disappointment.  The problem was that I estimated that the IV of the February options would fall from 35 to 33 (as that is what January options carried with four weeks of remaining life.  IV fell all the way to 27 and reduced the gain that I originally expected.

Happy trading.

Terry

How to Play the EBAY Earnings Announcement

The following is a list of trades I made I made in my personal account this morning.

EBAY will disclose earnings after the close on Wednesday, January 16th.  As usual, Implied Volatility (IV) of the Jan-13 options (66) is greater than the Feb-13 options (35) due to the uncertainty of the earnings numbers.  This gives calendar spreads a considerable IV advantage.

According to WhisperNumbers.com, over the last 10 years, EBAY has exceeded the whisper numbers by more than a 2 – 1 margin.  This time around, both the analysts and the whisperers agree on a $.69 earnings number.

The trend for the company is surely positive, another indicator that things might be getting better:

ebay graph

It appears that at the last two earnings announcement dates the stock has gapped higher, nearly 10% both times.  The big danger with buying calendar spreads is that kind of a move.  For that reason, I plan to hedge my bet here and buy some uncovered out-of-the-money Feb-13 57.5 calls just in case history repeats itself.

Today, with EBAY trading at $53.00,  I bought 20 each Feb-13 – Jan-13 calendar spreads at the 50 and 52.5 strikes (using puts) and at the 55 strike using calls.  In addition, I stuck my head way out and bought 10 uncovered Feb-13 57.5 calls.

One of the persistent problems with placing calendar spreads in advance of earnings is that the IV of the long side falls after the announcement.  I suspect that this will not be much of a problem this time around.  I checked back a month ago and learned that IV for the Jan-13 options series with four weeks of remaining life was 33, which is only marginally lower than today’s Feb-13 level 35.  So the Feb-13 option prices shouldn’t plummet after the January options expire.

Here is the risk profile graph for my positions:

ebay risk profile graph

These are the positions I have:

ebay positions

  For those of you who prefer seeing these trades as I placed them, here they are:BTO (buy to open) 10 EBAY Feb-13 50 puts (EBAY130216P50)
STO (sell to open) 10 EBAY Jan-13 50 puts (EBAY130129P50) for a debit of $.50  (buying a calendar)

BTO 20 EBAY Feb-13 52.5 puts (EBAY130216P52.5)
STO 20 EBAY Jan-13 52.5 puts (EBAY130129P52.5) for a debit of $.56  (buying a calendar)

BTO 20 EBAY Feb-13 55 calls (EBAY130216C55)
STO 20 EBAY Jan-13 55 calls (EBAY130129C55) for a debit of $.54  (buying a calendar)

BTO 10 EBAY Feb-13 57.5 calls (EBAY130216C57.5) for $.58
These positions cost $3780 to place and commissions worked out to $162.50 at thinkorswim for a total investment of $3942.50.  I placed these trades when EBAY was trading right at $53.  According to the graph, EBAY can fall over $4.00 before I lose anything on the downside, and a profit will result no matter how much it moves higher.  I really like these possibilities.

With a month to go until expiration, an at-the-money EBAY option should be trading about $1.50, or almost three times as much as the average calendar spread here costs.  If the stock ends up Friday afternoon near any one of the strikes for these calendar spreads, one of the spreads should be a triple-bagger.

The graph shows that if EBAY closes at any point between $52 and $56 on Friday, these positions could make as much as 100% (including commissions, our best goal should be in the 70% to 80% range, however, especially if we close them all out before waiting until the last minute).

The big risk is on the downside.  If the stock falls more than $4, a loss would occur.  If you wanted to expand the downside break-even point you would buy additional spreads at the 50 strike.

I want to thank our old friend Fred for sending along this possible strategy.  If you do it and it doesn’t  work out, please blame Fred instead of me.  I won’t blame him no matter what happens – he has given me so many good ideas over the years that I will still be way ahead if this one does badly.

As usual, don’t invest any money that you can’t afford to lose.  Good luck to all of us.

Closing Out the Wells Fargo Spreads
Yesterday I shared with you some trades I made in advance of Wells Fargo’s (WFC) earnings announcement before the bell today.  I bought 30 Feb-13 – Jan2-13 35 call calendar spreads for $.34, shelling out $1020 plus $75 in commissions at thinkorswim.  I also bought 30 Feb-13 – Jan2-13 diagonal call spreads (buying 36 calls and selling 35.5) for a debit of $.16. (There is a small maintenance requirement here for one day.)  These cost me $480 plus $75 in commissions.  My total money at risk is $1500 plus $150 in commissions, or $1650.
Earnings slightly exceeded the whisper numbers but the stock fell about $.60 from yesterday’s close (a change which was well within the profit range.  Rather than try to squeeze out a few extra dollars of profit, I decided to take the gains that were there at 10:30.
I bought back the Jan2-13 expiring calls for $.03 (thinkorswim does not charge a commission when you buy back a short call for $.05 or less).  Then I sold the Feb-13 36 calls for $.31.  This worked out to a net credit of $.28 compared to the $.16 I had paid for the spread.
Then I placed a limit order to close out the 35 calendar spread for $.55 and it executed quickly.  That spread had cost me $.34 so there was a nice profit there as well.
In total, I collected $2490 for the two spreads and paid $112.50 in commissions for a net gain after commissions of $727.50 ($2387.50 – $1650.00).
These trades made 44% on the investment for the day.  I might have collected a bit more if I had waited, but as the old adages go, you don’t go broke taking profits, and bulls make money and bears make money but pigs get slaughtered.
It is a happy day for me whenever I can collect 44% after commissions for a day of trading.  Most people would be delighted to make that much on their money for an entire year.
I will be looking for similar pre-earnings plays where strong implied volatility advantages are often possible, and will pass them along to you.

Wells Fargo & Company (WFC) will announce earnings tomorrow.  What is interesting to me is that Implied Volatility of the Weeklys that expire tomorrow is 52 while the IV of the February options is only 21.

As is often the case going into earnings, there is a huge IV advantage to buying calendar spreads, buying the “cheaper” February options and selling the “costlier” Weeklys with only one day of remaining life.

The important thing, as always when trading calendar spreads, is to pick the right strike price.  I like to make the assumption that I really don’t know which way the stock will move after the announcement but to buy calendar spreads at at least two strike prices so I have a range within which I will make money (maximum gains come when the stock closes on Friday at exactly a strike price of the calendar spreads you have bought).
The whisper number for WFC is $0.92, three cents ahead of the analysts’ estimate. WFC has a 42% positive surprise history (having topped the whisper in 14 of the 33 earnings reports for which we have data).
The average price movement (starting at next market open) within ten trading days of all earnings reports is +2.1%.  That is the important number for me.  That represents a move of about $.74 for a stock trading right at $35 today.
Today I bought in my personal account 30 Feb-13 – Jan2-13 35 call calendar spreads for $.34, shelling out $1020 plus $75 in commissions at thinkorswim.  I also bought 30 Feb-13 – Jan2-13 diagonal call spreads (buying 36 calls and selling 35.5) for a debit of $.16. (There is a small maintenance requirement here for one day.)  These cost me $480 plus $75 in commissions.  My total money at risk is $1500 plus $150 in commissions, or $1650.
At the end of the day tomorrow, I will buy back any in-the-money short calls I have and will probably unload the February calls as well.  The risk profile graph shows that I will make a gain if the stock moves less than $1 in either direction:  

If the stock moves less than a dollar either way I should make a profit.  If I am lucky enough for it to close between $35 and about $35.70, I could double my money.  It is sort of fun to have a little investment like this that could double in a single day.  Worst case scenario, I will have 60 calls which have a five weeks of remaining life.  It seems to me that it is unlikely that they will be worth less than an average of $.28 which would be a break-even number for me.

We all know that market makers have an incentive to push the stock price (through using their essentially unlimited market power) to manipulate the stock price to exactly a strike price on expiration Friday (after all, they are usually the sellers when the public buys puts and calls).  If the stock ends up exactly at a strike  price, all those puts and calls they have sold will expire worthless.

If they pick $35 as their price target, I will celebrate with a big night on the town this weekend.

On Monday I submitted an article to Seeking Alpha -, Why Herbalife Should Move Higher From Here

I recommended buying calendar spreads at one strike below the current price of Herbalife (HLF) and two strikes above the current price so that you didn’t much care which way the stock moved as long as it didn’t go absolutely crazy on the downside.

In a Terry’s Tips portfolio, we bought Feb-13 – Jan2-13 calendar spreads at the 35, 37.5, 40 and 42.5 strikes when the stock was trading at $28.57.  On Tuesday and Wednesday, the stock moved up by about $2.50 and we added another calendar at the 45 strike.

The company has made a public announcement today refuting the claims of Bill Ackman, and the stock has been gyrating in both directions, although not by huge margins.  As I write on my lunch break on Thursday, the stock is trading at $40, down about a dollar for the day.

Our little portfolio has gained 20% after commissions since Monday, and the risk profile graph shows that we should pick up even more tomorrow as long as the stock doesn’t fll by more than another $2 by the close tomorrow:

I am a little tempted to close out the positions and take a 20% gain for the week, but the break-even range seems large enough that I will wait another day and  hope for another 10% or so.

Two messages  again today – first, a reminder that in celebration of the New Year, I am making the best offer to come on board that I have ever offered.  The offer expires in three days.  Don’t miss out.

Second, one of our portfolios gained an astonishing 124% last week.  I want to tell you about this portfolio, reveal the exact positions we hold, and show how it should unfold next week (and thereafter).

How the Dog of Dogs Portfolio Made 124% Last Week

This portfolio is based on the expectation that the volatility ETN VXX will continue its downward slope in the future.  The following is an excerpt from the weekly newsletter I send to my paying subscribers:

Summary of Dog of Dogs Portfolio

This $5000 portfolio is designed to take advantage of the long-term inevitable price pattern of VXX.. Because of contango, the way it is constructed, and the management fee, the stock is destined to fall over the long term.  Twice in the last three years, 1 – 4 reverse splits had to be made so there would be some reasonable price to trade.  We use calendar spreads at strikes below the underlying price.
As a reminder why we call this the Dog of Dogs portfolio, here is the 4-year graph of this ETN since it was formed:

The stock never really traded for $2800 as the graph suggests – adjusting for the two reverse splits made it seem that way.  This surely is the worst-performing “stock” in the entire universe over the past four years.

Here are the current positions we hold in this portfolio:

Results for the week: With VXX down $7.88 (22.2%) for the week, the portfolio gained $3,361 or 142.1%. We were patient while VXX headed higher due to fiscal cliff uncertainties, and this week our patience was rewarded as VXX fell big-time. Next week looks potentially great even if VXX does not continue to fall. A flat or lower price for VXX should result in a double-digit gain for the week.

The risk profile graph shows that if the stock is at the same level ($27.55) next Friday, the premium we collect from having sold puts at the 27, 28, and 28.5 strikes will decay sufficiently to return a gain of $740 (about 12%) even if the stock does not fall as history suggests it will. The graph also shows that a double-digit gain for the week can be expected at almost any lower price for the stock as well (this is possible because we hold six extra uncovered long puts).

Note: Most Terry’s Tips paying subscribers mirror this portfolio (and/or others of our 8 total portfolio offerings) through the Auto-Trade program at thinkorswim rather than making the trades on their own.  We invite you to join us as a paying subscriber at the lowest price we have ever offered.