Thursday, July 9, 2009

Chevron On Deck

Chevron earnings on deck tonight at 5 PM EST. Let's take a look at what the options board is pricing in. While current IV (gold line) sits around 35%, 30 day HV is residing around 26%. So the options seem to be expecting (e.g. pricing in) a decent
up tick in the stocks realized volatility; at least more so than the last few earnings plays I've look at (FDO, AA). July expiration options have a mere 6 days left until expiration, so analyzing these front month options may give us a better glimpse as to what type of move CVX is expected to make off of tonight's earnings.

CVX is currently trading around $63. The front month strangle (July 60 put +July 65 call) is only trading around $.85. Those buying the strangle would want to see CVX above $65.85 or below $59.15 by next Friday (assuming they hold all the way to expiration). That's about a 4.5% move up and a 6% move down. Not really a blow-out move by any stretch of the imagination.
August expiraiton options have quite a bit more premium to play with, providing more flexibility in structuring short volatility trades into earnings. Let's consider a short Aug 55-70 strangle.

Sell Aug 70 call for $.50
Sell Aug 55 put for $.65
Net Credit = $1.15

Bringing in $1.15 credit puts the upper breakeven around $71.15 and the lower breakeven around $53.85 (assuming you hold to expiration).

As mentioned in previous earnings post (APOL, RIMM), we're betting CVX moves less than expected and volatility gets crushed post earnings (perhaps closer in line to current 30 day HV of 26%).

Those wanting some protection in case CVX gaps too much could consider buying an AUG 50 put and AUG 75 call to create an iron condor. The trade-off is you're giving up about $.30 of the strangle's net credit to acheive the limited risk.

11 comments:

Bain said...

I really like the visualization of the profit/loss zone on your last screenshot. Do you mind sharing what software you use?
Thanks,
Jeremy

Tyler Craig said...

Jeremy,

The software I use for charting and risk graphs is the EduTrader. www.edutradersoftware.com

I use SnagIt (www.snagit.com) to copy the risk graphs and SnagIt Editor to shade in the profit and loss zones.

Happy Trading-

Anonymous said...

Does calendar spreads work on IV crush?

Tyler Craig said...

Anon,

Good question. Assuming you buy a calendar spread (buy a long term option and sell a short term option), it does not benefit from a drop in volatility. In greek terms we would say a long calendar is Positive vega. As such you actually want to see an increase in implied volatility, not a decrease. Basically long term options are more affected by a change in volatility than short term options. So IV crush would hurt your long option more than it helps the short option.

I introduced vega on my June 30th post and will elaborate on it in subsequent posts.

Sam said...

Hello Tyler,

I enjoy reading your postings very much as I find it to be one of the MOST informative and in-sightful blogs out there, especially these recent articles on selling Strangles on high IV-HV spread options.

Now I happen to come across another trader blog who claim to like do the reverse, that is to buy Strangles on lower IV options. He mentioned that Vega "should be low for such trades to be more successful", even though I don't see this to be such an important factor (or is it?).

So if we're to SELL Strangles, do we really need the Vega should be as high as possible? If so, how high is considered high?

Thank you in advance. Keep up your great postings, as always!!

Sam

3percenter said...

GS reports Tuesday 7/14. IV is way up, hence the July options are still juiced! Any reason not to put on a 130/155 short strangle? It's a $2.00 credit. And theta is killing it since it expires next week.

Justin

Tyler Craig said...

Justin,

IV is definately overpricing current GS realized vol, so it would at least be one worth considering. VOlatility usually peaks before earnings, so since it reports on Tuesday you may considering waiting until then to place the trade, as IV may be higher at that point.

Furthermore, the effects of time decay between now and Tuesday will be negligible, so I don't think there's any rush in throwing a trade on today vs. Tuesday (I'll elaborate on time decay & earnings in a future post).

Also, GS may be at a completely different price next Tue before earnings, which means you may want a different range on the short strangle other than 130-155.

So I'd reassess the trade next week to run the numbers and make sure you're comfortable with the potential profit and the profit zone.

With all the voodoo going on in the Financial sector I've been a bit tepid to play in that space...

Tyler Craig said...

Sam,

Glad to hear your enjoying the site. I've got a post on VEGA in the works, so that should help clarify the nuances of VEGA and how it works. I introduced volatility in my June 30 post, so take a look see if you haven't.

Let me clarify the usage of the term IV and Vega. When IV goes up, option premiums go up; when IV goes down, option premiums go down. Vega is the greek that measures HOW MUCH your option will go up or down in value. In other words it quantifies how sensitive your option is to a 1 pt. change in IV.

So when you say, "Vega "should be low for such trades to be more successful". You (or the person you're quoting) meant to say you want IV low, not Vega. Technically you can't use the word "vega" and "implied volatility" interchangeably. They refer to two different things.

Just as it's important for us to have high (overpriced) IV when selling strangles or straddles, it's equally important to have low (underpriced) IV when buying strangles or straddles. So what he said is a correct statement.

When I enter a short strangle, yes I would like to see the IV as overpriced as possible- that means the option premiums are more juiced up (more expensive), which increases the likelihood they are too expensive.

How high is too high?- Good question. I usually compare it to the actual volatility of the stock (as measured by 30 or 10 day HV). If over the past 10 days the stock has exhibited 20% volatility and the options are pricing in 50% volatility, then unless the stock starts busting a move, the options are probably overpriced.

Conversely if the stock has realized 30% volatility over the last 10 days, and the options are pricing in (IV) 20% volatility, then unless the stock moves less and less, the options maybe underpriced.

Sam said...

Hi Tyler,

Thank you for your reply.


Sam

3percenter said...

So it looks like it was a good idea to wait until Tuesday morning to sell the strangle on GS. A gap like today's would change your strikes.

http://notablecalls.blogspot.com/2009/07/goldman-sachs-nysegs-upgraded-to-buy-at.html

Tyler Craig said...

Justin,

Yup-

Also, looks like GS reports earnings Tuesday morning, so those wanting to play it would have to enter today.