Thursday, June 3, 2010

Trade idea for GOOG on 6/4

Date:               6/4/10             
Underlying:    GOOG
Trade Idea:    Sell (10) GOOG 560 naked calls @.50

Pre-Trade Analysis: I'm thinking about doing a similar play as last month and selling naked calls on GOOG. It's had a nice bounce the last few trading sessions. I choose a strike price well above possible resistance and its new trendline. The yellow bar is OPEX, the blue bar is the needed trendline to hit the naked strike by OPEX. I would look to possibly close this trade out if we closed above resistance at $525, it depends on how fast we get there. If that happened on trade day of 6/4 you're looking at a $1950 loss. So the initial RoR is ($500/1950) = 25%. If it gets there early next week you're looking at a $800 loss. Each day we don't continue with the new steeper trajectory and/or break resistance and I would just look to stay short until expiration. There are no earnings between now and 6/18, nor is there any expected GOOG related news. Other than a monster surprise on the upside for the employment report on 6/4 and I'm comfortable with this trade. It's relatively low risk with an implied possibility of loss at expiration of 4.5%

Entry Point:   Sell (10) June $560 call for .50 with GOOG @ $505                                   
Exit Point: Reevaluate trade if GOOG breaks resistance at $525

Risk: $1950    Return: $500              RoR: 26%

Additional Info: I think it's important to keep in mind that the industry standard for figuring out the probability of expiring worthless is the one sigma at 68%. This is dangerous in my mind as this lulls you in to a safer state of mind. This kind of thinking disregards or doesn't pay enough emphasis on the fact that 32% of the time these odds are wrong, or worse than expected. For someone doing multiple trades and always using the default 2/3 or 68% to make decisions, I think this is discounting the true risk as obviously the more trades you make, the more you're going to see two and three sigma trades. So below I've created an Excel sheet that deannualizes IV and figures out the probability of a given stock hitting your strike price given the amount of trading days left until expiration. The real odds of the naked $560 strike finishing ITM is 9.25%. The TOS model below shows that probability of finishing ITM at 7%. I'm not sure why my math and TOS is different so I need to figure this out.

Post-Trade Analysis:



  1. Jason I like the idea of looking at the 1 and 2 sigma moves. Your trade analysis has really come a long way, awesome. I think the reason your number that you calculated is different from the number that TOS calculated is because you used the implied vol of the stock at 35.45% vs the implied vol of the actual option which is sitting about 8% lower in your second picture above at 28% ish. Try it with that number and let me know if you get close to the same answer.

  2. I'm headed to the airport so I will look at this when I get home on Monday. I need to make sure there is just a small rounding error or something simple, and not just that I somehow got lucky and got close. I'm thinking it might be that TOS used calendar days and I used trading days to figure out the sigma move. There are only two more calendar days than trading days and the difference is slight, I'll find it later.

    The bid/ask this morning for this trade was .50/.65. I went in at .57 and got filled at .60. Surprised to the upside, but makes me wonder. I was a touch hesitant that GOOG was up $2 when SPX was down 16, but it doesn't change my analysis. I reevaluate if it breaks resistance.

  3. I closed this trade out today for .02. It's literally throwing away $24 after commission but it's worth the psychological capital to close out my June trades and start looking at July.