Example Earnings Trade: Selling Options on STZ | Cameron May | 12-27-19 | Options Week in Review

Example Earnings Trade: Selling Options on STZ | Cameron May | 12-27-19 | Options Week in Review


sometimes options prices go really high
right before earnings so what might an options trader do with that sort of
information let’s explore it good afternoon and welcome back everyone
my name is Cameron May it’s 3:30 Eastern Standard Time on a Friday afternoon
there’s 30 minutes left in the trading week that means it’s time to get back
into our ongoing series of discussions called the options we can review or we
take a look back at the way at the week that was take a look at the week to come
so I’m looking forward to it hello to all of you our returning veterans thanks
for joining me week after week I already see Robert and Sal
Ross Charles and Remy saying hi there to the group so welcome if you hear for the
very first time I want to welcome you as well and if you’re listening in on
YouTube after the fact enjoy the show but be aware that you’re
invited to join us live on Friday afternoons if you’d like to learn on
your personal calendar 3:30 Eastern Standard times when we kick things off
alright so we’re gonna spend about 20 to 30 minutes together today taking a look
at that week and maybe planning a trade burnings as an example of what a trader
might do through an earnings announcement so let’s get right to it
very first thing that we need to do is to consider the risks associated are
investing risks are real so some important information options are not
suitable for all investors transaction costs are important factors and should
be a value it should be considered when evaluating any trade all investing
involves risks including risk of loss any investment decision you make in your
self-directed account is solely your responsibility and there’s an overview
of your option Greeks all right so let’s set an agenda for the day three items on
the agenda we’re going to take a look at what’s happening with a stock market in
the options market what’s happened over the last five days then we’re going to
use the TD Ameritrade calm web site to explore what might be some of the
driving of the motivating factors for that price activity and then we’re gonna
take a look at the week ahead and actually we’re gonna look a few weeks
ahead due to kind of a unique situation that we’re in right now we’re in the
middle of holidays kind of a quiet time so we might maybe a look a little bit
further forward that we typically do but that’s what we want to do what I want
you to walk away with is an understanding for how you as a
self-directed investor might gather your own context and find the resources that
are available for you to get some gauge on what seems to be driving markets
right now so hello they are Alfred rich did I say hello to you hello rich great
to see you but let’s let’s go right to let’s go to thinkorswim see what’s been
happening with the S&P 500 so here’s a one-year chart obviously some traders
might use other time frames and other maybe even other indices to follow
what’s happening with a stock market but not a lot to cover here pretty much the
same story that we’ve been repeating for several weeks in a row now
yes we’ve hit all-time highs again on the Dow the Nasdaq and the S&P 500
so for bullish options traders this has been a pretty good cooperative market
for those that are in bearish positions maybe not so much right with prices I
think on the S&P what do we hit nine record highs out of the last ten trading
sessions something like that and it looks like we’re just still trying to
hold on to to on to positive territory for today but overall yeah since last
week still pressing higher and how about as we plan new positions let’s just go
forward with an assumption maybe that trend is likely to continue obviously it
could reverse at any time making assumptions about the future just an
estimate right and another trader might have an entirely different view of
things but over the last decade or so the odds have worked out to be more in
the favor of buyer or not buyers but bulls versus versus bears
alright so though that’s the stock market condition and I think most of us
are aware of that what’s been happening with the options market where our
options prices right now alfrid rich Ramy Charles Ross fell Robert helped us
fill in those that are new to options trading our options price is high right
now we’re low right now cuz stock prices are not literally off the charts but
they’re higher than they’ve ever been what influence does that have on options
prices well let’s go have a look at the VIX the volatility index of the S&P 500
and this is a chart that some options traders will consult to see what’s
happening with options prices and when we see low figures on this chart
typically that means low prices for most strikes on most stocks most options if
if we are seeing higher values on this jar
typically that implies higher prices for options and yeah really we are pretty
low we came down to right close to 12 month lows earlier in the trading
session and we’ve been coming up but still historically speaking we haven’t
seen low much lower volatilities certainly not for the last 12 months
even going back historically over the over the last 20 years we’ve seen a low
percentage of times when volatility the volatility index has been lower than it
is right now so that translates to pretty low options prices for most
stocks at most strikes alright again you have to take that on a case-by-case
basis and as a matter of fact I’m going to find an exception to that for today’s
discussion all right so we have high stock prices we have low options prices
but that’s driven by typically bullish economic activity bullish news how do we
determine what’s driving that well there are some resources available on the TD
Ameritrade website so let’s flash over there see what that news might be so
what are the some of the things what are some of the broad themes in economic
news that seem to be grabbing a lot of the headlines that you’ve observed if
you want to chat that in I’m gonna go ahead and start commenting on this but
obviously we have presidential impeachment is something we talked about
last week that’s still in the process now the house has impeached president
Trump that’s now moving to a trial in the Senate however it hasn’t been
introduced to the Senate yet so we’re sort of in in what I call that limbo
right we’ll see when that gets introduced and whether the Senate has
the collective will to to impeach President Trump or to or to acquit but
I’ve talked in previous discussions and in recent discussions about how we’ve
seen a presidential impeachment before back in 1998 rolling into 1999 we had
President Clinton was impeached by the house ultimately acquitted by the Senate
and the market sister seemed to keep pressing higher through that whole
process and the months and the the weeks the months
and the year to follow so we don’t know if that’s setting a model for what to
expect here but in that one sample in history we seem to see bullishness if we
want to contrast that with what happened with President Nixon back in 1974 he
actually was he resigned from office some might say forced from office how
for whatever the circumstances the markets took that in addition to other
prevailing sentiments at the time to drive the S&P lower actually going down
about a but 25 percent in the few months that followed Nixon stepping away from
office however saw a full recovery within 12 months so this will be
interesting that’s sort of some of the news where do we check on the news well
we can pop up here to the research and ideas tab on the website and go to news
and check out the market right here the Market Snapshot area this is giving us a
headline right now down the ESPY rise as stocks extend record-setting rally we
already talked about that what else is contributing Veronica’s mentioning trade
you know what’s going on with trade well it seems like maybe there’s been an
easing there or some some progress made on the trade front right so the u.s. is
is a green cut back on some of their tariffs that China has agreed to
purchase some more US goods so maybe some progress there what else are we
missing out oh and and there have been reports from some corners of the
domestic marketplace that retail sales food we’re having a pretty strong
holiday season all right so we can check up on that news here but we can also
check our economic calendar if we go out to research and ideas click on calendar
this will default to today’s date and then we can go to economic events right
over here I will I’m not going to spend much time on this because it’s it’s kind
of been a quiet week it’s also been kind of a quiet week for earnings
announcements typically we would go back and look at the major economic news
developments and then look at earnings there aren’t really any S&P 500
companies that announced earnings this week and for economic events when you
see white on the calendar it means nothing really happened if you see a
light green a very pale green that means maybe a few fairly minor reports came
out that day if we see a darker green then we might have some bigger events so
if we look back at December 23rd on Monday we had new home sales reported I
don’t know if anybody followed new home sales but we’ve been keeping an eye on
sort of the ups and downs of the real estate market and it really has been
pretty up-and-down new home sales didn’t quite meet the consensus expectations we
were expecting an increase from seven hundred ten thousand units to seven
hundred thirty-five thousand units so an increase of twenty five thousand and
actually the net increase came in only at nine thousand up to seven hundred
nineteen thousand so that was a little bit of a disappointment there in the
real estate but then on Thursday we saw a little bit more promising potentially
news from the unemployment situation initial claims for unemployment these
are new claims for unemployment we’re at 235 thousand last week dropped to two
hundred twenty two thousand so down 13 thousand and that was a right in line
with the consensus expectation so a positive progress and right on target
for a report that’s seen quite a few surprises in recent weeks and then what
else are we missing just really some anecdotal reports really of retail sales
looking pretty strong we’ll see as we get more figures in the coming weeks how
the holidays round out but overall seems like investors at least in the way that
they’re behaving with their shares seem to like what they’re seeing
maybe it’s progress on trade maybe it’s maybe it’s strong retail sales maybe
it’s using a model of presidential impeachment for forecasting what they
might expect with the with the senate who knows what
happens there but overall stock prices going up options price is falling and
we’re moving into a continued area of relative quiet relative calm for the
next week or so so if we were to look at the week ahead and I’m not even gonna
look back at any earnings this will be the first time I’ve ever done that but
there really was pretty quiet period for this week a lot of companies don’t
necessarily like apparently to announce during the holidays when shareholders
might be distracted from their good news who knows but in the in the coming week
we have next week economic news starts to pick up a little bit you can still
see on the on the New Year’s holiday nothing happening but on Monday we have
pending home sales on Tuesday consumer confidence on Thursday of course the
weekly jobless claims and then on Friday construction spending so going back to
that real estate theme we’ll see if if things can pick up a little bit there
but what I wanted to talk about for today now that we have a little bit of
context of what what the markets are doing what what might be contributing to
those market activities I do want to look at a company that’s announcing
earnings we’re moving out here a couple of weeks and coming up here on the 8th
we have we come up here to the top I’m kind of cutting things off a little bit
there we go let’s make sure you can see the whole word earnings up at the top
let’s switch our calendar over to earnings we’re now on January 8th so
looking a couple of weeks ahead and we have Constellation Brands symbol stz
we’re finally getting some of those larger companies announcing earnings and
I wanted to talk about or revisit a trade that we did on Constellation
Brands back in March we’ve only done one trade this year 2019 so we’re gonna kick
off 2020 with a new trade on on constellation brands as our next example
trade but the last trade that we did as we go to our monitor page
I’m gonna go to the accounts statement and we’re looking 365 days back we’ve
sorted by just stz so we’re just seeing the trades for constellation brands and
you can see on March 29th we bought a straddle so what is a straddle that’s
when you buy an out of the money call and you buy an out of the money put on
the same apartment and at the money calling and at the money put I think
it’s strangle because that’s what I’m gonna be talking about but a straddle is
when we buy a long straddle buy out the money call buying at the money put same
strike and in this case we paid about fourteen and a half dollars for that and
later following an earnings announcement sold that for $32 what actually happened
is we lost the full investment in the put but made a big return on the call
and that’s a pretty typical hoped for outcome for a straddle one side of the
trade is expected to lose money the other side hopefully we’ll make more
than that what voice has decided to struggle the last moment on Friday
anyway but when I launched today’s discussion I kind of teased that right
before an earnings announcement what typically happens with options prices
well very commonly you’ll see options prices go up and be quite expensive
right before an earnings announcement that’s because traders might be
anticipating something to happen from that earnings and therefore the
speculators are willing to spend more and the hedgers might just be forced to
pay more who knows right again much to drop saying who knows well we can look
at charts and see what the historical tendency has been for a stock so let’s
look at stz and let’s come up and add implied volatility using our studies
function here so let’s choose implied volatility add selected click apply and
then ok so here the red and blue icons represent our earnings announcements
we can look up and see price reaction and we look we can look down below and
see the implied volatility specifically for constellation brands you’ll
sometimes if you hear me slip I’ll call it stars I was talking with Pat Mullaly
about that we both do that yeah it’s constellation brands but you
can see in the days and weeks leading up to an earnings announcement typically we
see a ramping up of implied volatility and then a big drop and that reflects an
increase in demand for the options and then a drop right really the day after
so what you wind up with are options that are comparatively expensive right
before earnings or in those weeks leading up to earnings so what might a
trader do with that information last time we wound up paying for those
options this time I thought for an example we would sell those options we
can see there’s that implied volatility ramping up again here’s that earnings
announcement on the near-term horizon and so what a trader might expect from
that is options prices are high and as we go to the trade tab for stz let’s
look out in an expiration that’s out beyond earnings and you can see right
over here our market maker move for that expiration is projecting about a 12
dollar move up or down if you’re not familiar with this plus or minus here
this is extrapolating the current price of these options to calculate how much
options traders are sort of pricing in in anticipation of how far they think
maybe the the stock might rise or fall on the next earnings announcement this
is a stock that has a pretty good history of moving on earnings you can
see if we revisit history here the days just before earnings that was a $210
stock right after $185 stock if we go back further than that in the days just
before it was $180 stock the days just after it was a $200 stock and we could
just keep doing that but yeah 175 up to 195 so you can see 10 $20 move
in just a few days so that maybe being priced in to traders expectations here
plus or minus twelve dollars gives us a $24 net range all right
so what if we were to sell a call and sell a put at the same time on this
stock well if we sell a call that would be a trade that benefits of a stock
remains below a certain level by expiration if we sell a put that does
well if the stock is above our strike price price at expiration but we’re
doing this right at a time when the stock is actually expected to go
shooting up or shooting down it might not that’s what we’re actually gonna
hope for in this scenario but what if we were to sell our options if if traders
have priced options with an expectation that we might go up 12 or down 12 well
what if we go up like I don’t know 15 18 go further than expect it up and further
than expected down that may increase the probability of success on the trade
let’s have a look at where the stock a look at this is right at $189 right now
so if we were to go $12 out of the money on our puts that would take us wet down
to about a hundred and seventy seven how to take us right down to about right
here that would get us just outside the range where the traders other traders
are currently pricing options anticipating movement now that may be
enough for some traders they may feel comfortable with that others might want
to go just a little bit further yeah so they Jarrell this is called a strangle
that’s right what we’re looking to do is sell and out of the money put selling
out of the money call on the same stock at the same time that’s what we call a
strangle it’s kind of like we’re getting our hands around the the price of the
stock now if we push this a little bit further
what if we were to go like the 172 and a half put that is right now about $17
away from the current price of the stock and that’s outside the range that it
looks like other traders are currently expecting the stock to go come
expiration all right that may improve the likelihood that we don’t get burned
on the put side what would what would be its corollary on the on the call side if
we were to come over here add let’s say about 17 bucks to the – 189 that’s gonna
put us up around 205 206 let’s go to the 205 205 trading right around $1 and
that’s yeah about actually that’s about sorry I did my math wrong no no I did
that right that’s about 16 dollars away from where the stock is right now and if
we were to sell that call we could collect a dollar here and at the 172 and
a half collect a little bit more than a dollar maybe $1 $10 15 maybe a dollar 20
let’s say we get two dollars and 20 cents between those two traits that
would represent the maximum gain on this trade and we would realize that game if
both contracts expire worthless or in other words if the stock is between our
two strikes at expiration let’s draw that on the chart so we’re looking at
172 has 172 and a half right about here on the downside and 205 is right up here so you can see we could have even a
pretty strong move on earnings and still work out in either direction now another
thing that I noticed with this stock is it does tend to have these strong moves
but then what happens it’s had a tendency at least this year I haven’t
looked back previous years it’ll have a tendency to move back against the grain
of the big move so even if we got a strong move down for example maybe it
would just move back up here and put us back into more comfortable territory if
we have a strong move let’s see we had a strong move up here and then we drifted
down this one took a little bit longer to drift down though what do we have
back here we had a strong move down and then move back up against the grain of
that trade the one example or we didn’t see that
I didn’t mean to draw up right there let me just remove that drawing here we had
a strong move up and only a little bit of a pullback against the grain here so
overall though let’s see how this strangle may work out let’s go up place
a trade on this now if you’re not terribly familiar with that more
advanced option strategies like strangles you may want to check out the
webcast it’s called advanced option strategies you can watch that live on
Thursdays it’s taught by Ken Rose or I’ll just link one okay I’ll link an
archive for you I’ll put it right up there in the upper right hand corner so
you can watch that on YouTube after the fact or if you’re watching the YouTube
archive right now you’ll be able to see that but let’s go ahead and place this
order I’m going to come down to that 2:05 call and we’re gonna sell it so
we’re gonna click on the bid price that creates our sell order for our calls I’m
gonna come up to the puts and click on the bid price but I have to hold down
the ctrl key on my keyboard hold down the control key click on the bid price
and that adds a short put to our short call position now
the combined reward potential of this trade right now is about two dollars and
20 cents per share so on one contract or one pair of contracts that’s about $220
you’d have to subtract out a little bit of commissions there or transaction fees
but what’s the risk of this trade well it’s significant as a matter of
fact on the short call it’s unlimited if the stock has a big gap up that short
call does represent represent some significant risk there are some ways
that we might mitigate that risk to some extent I’m not going to explore those
today though but just be aware this short strangle or naked strangle is only
one of a number of different but similar strategies but I just sort of like to
mix it up and do a different one from time to time but just be aware there’s
risk if the stock gaps up too high it’s also risk of the stock gaps down to low
what we want for this trade is for the stock to remain or be between our
strikes at expiration all right so let’s come here and click confirm and send
while the markets are still open and oh actually let’s edit this order how about
we dial this down just a bit how about we do two contracts there we go so we’re
looking for a $220 credit two contracts that’s $440 let’s click confirm and send
any time we put in a limit order though we run the risk that the order might not
fill there our transaction fees associated with this trade so we’ll have
to bear those in mind that leaves us with a net credit projection there
let’s click send see if we get a quick fill we only have a couple of minutes
left I’m not gonna be paying very patient with this if it’s not giving us
the credit we’re looking for that order still working you can see right now
we’re trading right at 212 that’s the market price we’re looking at pardon me
220 we’re looking for 220 while I’m talking I’m actually gonna rework that
let’s cancel and replace that order back off on our credit requirement a couple
of pennies hopefully improve the odds of a quick fill and let’s click confirm and
send again still those transaction costs but let’s send that off cancel that
order hoping to get a quick fill here before the markets close before I have
to send you off into your weekend and oh this one’s being a little bit
stubborn all right one more time right-click canceled replace the order
as we do this are we racking up more and more transaction fees nope
it’s only the one set of transaction fees well let’s change it first let’s
reduce the credit requirement again confirm and send there we go
sold at 2:15 okay so there we go so we put on what’s known
as a short or a naked strangle The Naked means that we are exposed
if the stock makes a big move up or a big move down we’re not really covered
there the short put might be covered by cash but the long call we don’t have an
underlying position in stars or stars Constellation Brands anyway so that’s
gonna do it for today it’s it’s been an interesting discussion we see the
markets just pressing higher and higher I just wanted to talk about what might
be pushing that and we now know where we might go to look at a calendar of events
to see what’s transpired and what might be coming up for next week so if you’re
looking for your own context here do I suggest you do your homework assignment
for today go have a look at that calendar see what’s on the calendar for
next week see what’s on the calendar for the week after that and it and it might
provide some context for what to expect all right everybody time for me to set
you loose we’ll keep an eye on this short strangle see if it worked out as
well as our long strangle did back in March April and May but we’re gonna get
an answer faster than that last trade will probably no come the 8th of January
how this thing is likely to play out but yeah you’ve earned your weekend let me
set you loose everybody thanks for joining me today we’re going to do this
again next week you’re invited to come back we’re going to take another look at
what happened in this coming week and as a heads up for next week I’m going to be
taking a little bit of a I know I don’t know if it’s gonna be
terribly different but we’re combining Mike vilette’s market volatility
discussion into the option weekend options we can review so maybe a little
bit of a different flavor but I think it’s gonna be look it’s gonna look
pretty much the same all right rich yeah I have a great weekend everybody happy
new year I will see you in 2020 remember that
risks are real we did use real examples in today’s discussion it’s not a
recommendation or endorsement of those securities or those strategies I will
see you next week or in some other class between now and then but whenever I see
you again until that moment arrives I want to wish you the very best of what
happy investing but why

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