IBM:? A Volatility Bet Into Earnings
By: John J. Critchley, Jr.
International Business Machines (IBM) begins the avalanche of earnings in the technology sector as tech juggernaut reports after the bell on Tuesday.? Earnings are expected to rise up over 10% from a year ago when it reports its third quarter earnings. The consensus estimate is $3.61 per share, up from earnings of $3.28 per share a year ago.
We noticed a quite compelling way to play the earnings release from an implied volatility standpoint.
Trade idea?A Medium Term Long Options Volatility/Premium Play
If you are wary of buying options that expire in a few days and would like to have more time for your ?bet? to play out,? one could go out to the November?12 monthly options, which present some enticing medium term value. ?
The play:
a)?? ?Buy November ?12 210 straddle for $ 9.35.? The implied volatility of this straddle is? reasonably priced at 17.95% IV (Implied Volatility).?
Net debit: $9.35
Source: http://sogotrade.com? ?
Why the November 210 line? Why this is considered reasonably priced? There are three reasons:
1)?? ? The case can be made that the straddle may be a bargain if one considers that you have one month of time left before expiration, an earnings event and an important macro event, the presidential election on November 6th.
2)?? ? If we look at the decline in 30 day Implied Volatility post-earnings, the average decline over the past four earnings has been approximately 10.76%.
The current 30 day Implied Volatility is around 17.95 %.? We certainly expect a downward move post earnings in Implied Volatility, but the move should not be as dramatic as in the past 4 quarters.? If the 30 day IV drops as much as it has in the past 4 quarters, then we would see 30 day IV go to 7.19%.? That?s not going to happen.? We don?t expect that dramatic a decline and a more reasonable expectation would be IV to mean revert and contract anywhere from 4% to 6 % (just a guess).? This would take IV to a multiyear low, but nowhere near other historical post earnings IV drops.
3)????? The average 30 day Implied volatility going into an earnings release over the past? four quarters has been 26.5925%
In the chart below, the yellow lines point to the 30 day IV over the past 4 earnings release, whereas the blue represents the current 30 day IV going into the earnings release on Tuesday October 16th.? The current 30 day IV is approximately 18%, significantly below historical pre-earnings IV calculations.
Source: Livevol(R) Pro (www.livevol.com)
Risk:? The earnings report does not cause the expected movement in the underlying.? The vega of the November 210 options are approximately $.102? If the underlying does not move and IV contracts as expected (4%-6%) you can expect to lose anywhere from $.80 to $1.20.??? Be forewarned.?? This play is for speculative monies only.
Stay tuned…
Notes: Prices quoted where the prices at time of submission and do not reflect current market prices.? You are solely responsible for your own trading and investments decisions and the ideas presented in this article are trade analysis, not recommendations.