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Volatility report - week 07 - earnings, expected moves and trade setups (SPY, QQQ, IWM & SHOP)

Volatility report - week 07 - earnings, expected moves and trade setups (SPY, QQQ, IWM & SHOP)

Options 10 minutes to read
Koen Hoorelbeke

Investment and Options Strategist

Summary:  Our weekly Volatility Report provides a comprehensive overview of expected price movements and evaluates the implied volatility rankings for upcoming earnings, key indices, and ETFs. In this edition, we delve into potential trade setups for a curated selection of ETFs and stocks, including SPY, QQQ, IWM, and SHOP. Particularly for SPY, we highlight a trade setup suitable for hedging strategies, offering a strategic approach for those who may have concerns about the current market peaks and seek to safeguard against downside risks.

Volatility report - week 07
(Feb 12 - 16, '24)

Welcome to this week's Volatility Report, a guide for traders and investors seeking to navigate the dynamic world of stock market fluctuations. In this report, we list the expected movements and implied volatility rankings* of stocks with upcoming earnings announcements, as well as key indices and ETFs. In this edition we'll also have a look at some possible trade setups for a selection of ETF's and stocks in the list; SPY, QQQ, IWM and SHOP

Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

 

Expected moves and volatility

Volatility and Expected Moves Analysis

Expected moves**, derived from at-the-money strike prices post-earnings**, indicate potential price volatility.

In the table above you'll find the following data:

  • Volatility Comparison: Implied volatility (IV) is currently contrasted against the 30-day historical figure to assess market expectations. A significant disparity often marks a prime scenario for premium selling.
  • IV Rank Insights: IV Rank situates the current IV within the past year's range. Values above 20% generally signal higher-than-average volatility, favoring premium selling, while lower values suggest caution for such strategies.
  • Sector Highlights: Financial firms, including Morgan Stanley and Goldman Sachs, are poised to report, with anticipated modest price movements. In contrast, larger expected moves for tech companies like Microsoft and Netflix indicate market anticipation of their earnings results.
  • Strategic Considerations: For traders, higher expected moves in the tech sector suggest the potential for volatility strategies, while lower moves in financials may align with range-bound positions.
  • Upcoming Economic Data: Key releases, particularly Retail Sales and Initial Jobless Claims, may introduce additional market volatility, reinforcing the value of expected move and IV in strategy development.
  • Highlighted Stocks:

    The list contains 4 highlighted stocks which each have 3 trade setup ideas (bullish, neutral, bearish). These ideas are listed below.

In this section of our volatility report, we're focusing on three credit and/or debit strategies that align with various market outlooks for our featured stocks. For each stock, we present a bullish, neutral, and bearish trade setup, designed to match your expectations for the stock’s future price action.

Think of these strategies as starting points to shape your trading plans. Each setup is flexible – you can adjust the strike prices and the widths of the spreads (set by default at $5) to suit your trading needs. The credit spreads we've chosen are bold, with strike prices set near the current price of the stock to seek higher rewards at increased risk. Feel empowered to place these strikes further away or closer based on your own market analysis and confidence.

Remember, these setups are foundational guides. It’s essential to refine them to fit your individual trading style and outlook, ensuring they support your trading objectives and risk management preferences.

SPDR® S&P 500® ETF (SPY)

This report outlines three trade setups for the SPDR S&P 500 ETF Trust (SPY) to align with varying market conditions. While the bullish and neutral strategies are designed for specific market movements, the bearish setup is particularly notable as a hedge. With an expiry six months from now, the purpose of this bearish debit put spread is to act as insurance against potential significant market corrections. This setup can provide portfolio protection by offsetting losses during unexpected downturns.

    1. Bullish Trade Setup (Credit Put Spread):

      • The trader has set up a credit put spread by selling a put option with a strike price of 490 and buying a put option with a lower strike price of 485, expiring on 21-Jun-2024.
      • The credit received from the trade is $130.00 USD, which is the maximum profit the trader can earn if SPY remains above $490 by expiration.
      • The maximum risk is the difference in the strike prices ($500) minus the credit received, which is $370.00 USD.
      • The breakeven price for the trade would be $488.70, calculated by subtracting the premium received from the higher strike price.

    2. Neutral Trade Setup (Iron Condor):

      • This iron condor involves selling a call option with a strike price of 520 and selling a put option with a strike price of 490, while simultaneously buying a call option at 515 and a put option at 485, all expiring on 15-Mar-2024.
      • The net premium received is $216.00 USD, which would be the maximum profit if SPY's price stays within the range of the sold strike prices ($520 for the call and $490 for the put) by the expiration date.
      • The maximum risk is the difference between the strikes of the wider spread ($500) minus the net premium received, totaling $284.00 USD.
      • The breakeven points would be $522.16 on the upper side and $487.84 on the lower side.

    3. Bearish Trade Setup (Debit Put Spread):

      • This setup is a debit put spread, which is established by buying a put option with a higher strike price of 490 and selling a put option with a lower strike price of 475, expiring on 21-Jun-2024.
      • The trade costs the trader a premium of $281.00 USD, which is also the maximum potential loss if the trade moves against them and SPY ends up above $490 by expiration.
      • The maximum potential profit is the difference between the strike prices ($1500) minus the cost of the spread, which is $1,219.00 USD.
      • The breakeven point for this trade is calculated by subtracting the net premium from the higher strike price, which would be $487.19.

These trade setups provide a strategic approach based on varying market outlooks, each with their own risk profile and potential rewards. The credit put spread and iron condor are premium collection strategies that benefit if the underlying remains within a certain price range, while the debit put spread is a directional trade that profits if the underlying decreases in price. The margin impact, maximum risk, and maximum profit for each setup must be considered in the context of the trader's individual risk tolerance and market expectations.

Invesco QQQ Trust, Series 1 (QQQ)

    1. Bullish Trade Setup (Credit Put Spread):

      • The setup involves selling a put option with a higher strike price of 430 and buying a put option with a lower strike price of 425, both expiring on 15-Mar-2024.
      • The trader receives a credit of $127.00 USD, which is the maximum profit if QQQ stays above $430 by expiration.
      • The maximum risk is the difference between the strike prices ($500) minus the premium received, which totals $373.00 USD.
      • The breakeven price for this trade is $428.73 (the higher strike put minus the credit received).

    2. Neutral Trade Setup (Iron Condor):

      • This iron condor is established by selling a call option with a strike price of 455 and selling a put option with a strike price of 420, while simultaneously buying a call option at 450 and a put option at 425, all expiring on 15-Mar-2024.
      • The net premium received is $221.00 USD, which would be the maximum profit if QQQ remains between the sold call strike of $455 and the sold put strike of $420 at expiration.
      • The maximum risk is $279.00 USD, which is the difference between the strikes of one of the spreads ($500) minus the premium received.
      • The breakeven points would be $417.79 on the downside (420 - 2.21) and $457.21 on the upside (455 + 2.21).

    3. Bearish Trade Setup (Credit Call Spread):

      • In this setup, a credit call spread is executed by selling a call option with a strike price of 455 and buying a call option with a higher strike price of 460.
      • The trader receives a credit of $125.00 USD, which is the maximum profit if QQQ stays below $455 by expiration.
      • The maximum risk for this trade is $375.00 USD, the difference between the strike prices ($500) minus the credit received.
      • The breakeven price is $456.25 (the sold call strike plus the credit received per share).

For each setup, the maximum profit is the premium received, and the maximum risk is the difference between the strikes minus the premium. The breakeven points indicate the stock price at which the trades will neither gain nor lose money at expiration. The margin impact reflects the required capital to maintain the positions, which varies according to the broker's margin requirements.

iShares Russell 2000 ETF (IWM)

  1. Bullish Trade Setup (Credit Put Spread):

    • The trade involves selling a put option with a higher strike price of 198 and buying a put option with a lower strike price of 193, both expiring on 15-Mar-2024.
    • The trader receives a credit of $130.00 USD, which is the maximum profit if IWM stays above $198 by expiration.
    • The maximum risk is the difference between the strike prices ($500) minus the credit received, which totals $370.00 USD.
    • The breakeven price for this trade is $195.70 (the higher strike put minus the credit received).

  2. Neutral Trade Setup (Iron Condor):

    • This iron condor consists of selling a call option with a strike price of 217 and selling a put option with a strike price of 192, while simultaneously buying a call option at 212 and a put option at 187, all expiring on 15-Mar-2024.
    • The net premium received is $205.00 USD, which is the maximum profit if IWM remains between the sold strike prices of $217 (call) and $192 (put) at expiration.
    • The maximum risk is $295.00 USD, which is the difference between the strikes of one of the spreads ($500) minus the premium received.
    • The breakeven points would be $189.95 on the downside (192 - 2.05) and $219.05 on the upside (217 + 2.05).

  3. Bearish Trade Setup (Debit Put Spread):

    • Here, the setup is a debit put spread, involving buying a put option with a strike price of 197 and selling a put option with a lower strike price of 192.
    • The trade costs the trader a debit of $99.00 USD, which is also the maximum potential loss if the trade goes against them and IWM ends up above $197 by expiration.
    • The maximum potential profit is the difference between the strike prices ($500) minus the cost of the spread, which is $401.00 USD.
    • The breakeven point for this trade is $196.01 (the higher strike put minus the cost of the spread).

In these setups, the first and second strategies involve selling premium to potentially profit from the time decay if the underlying index remains within a certain range by expiration. The third strategy is a directional trade where the trader is bearish and expects the price to drop. The premium received or paid indicates the maximum potential profit or loss, while the difference between the strike prices minus the premium indicates the maximum risk. The breakeven points are crucial for determining at which stock price the trades will neither gain nor lose money at expiration. The margin impact reflects the necessary capital to enter and maintain the positions, according to the broker's margin requirements.

Shopify, Inc. (SHOP)

    1. Bullish Trade Setup (Credit Put Spread):

      • This strategy involves selling a put with a higher strike price of 80 and buying a put with a lower strike price of 75, both expiring on 15-Mar-2024.
      • The trader receives a credit of $140.00 USD, which is the maximum profit if SHOP remains above $80 by expiration.
      • The maximum risk is the difference between the strike prices ($500) minus the premium received, totaling $360.00 USD.
      • The breakeven point for this trade is $78.60 (the sold put strike minus the credit received per share).

    2. Neutral Trade Setup (Iron Condor):

      • The iron condor consists of selling a call with a strike price of 110 and selling a put with a strike price of 80, while simultaneously buying a call at 105 and a put at 75, all expiring on 15-Mar-2024.
      • The net premium received is $218.00 USD, which is the maximum profit if SHOP trades between the sold call strike of $110 and the sold put strike of $80 at expiration.
      • The maximum risk is $282.00 USD, which is the difference between the strikes of one of the spreads ($500) minus the premium received.
      • The breakeven points are $77.82 on the downside (80 - 2.18) and $107.18 on the upside (105 + 2.18).

    3. Bearish Trade Setup (Debit Put Spread):

      • This setup is a debit put spread where a put option with a strike price of 80 is bought and a put option with a lower strike price of 75 is sold, indicating a bearish outlook.
      • The trader pays a debit of $140.00 USD, which is the maximum potential loss if SHOP ends up above $80 by expiration.
      • The maximum potential profit is the difference between the strike prices ($500) minus the cost of the spread, which is $360.00 USD.
      • The breakeven point for this trade is $78.60 (the sold put strike minus the cost of the spread per share).

    In summary, these setups are designed for different market expectations: the first for a bullish outlook, expecting the stock to not fall below the sold put strike; the second for a neutral market stance, capitalizing on range-bound trading; and the third for a bearish view, profiting if the stock price falls below the breakeven price. The premium received for the credit spreads represents the maximum gain, and the debit paid for the debit spread represents the maximum loss. The breakeven points are critical to identify the price level at which the trades break even at expiration. The margin impact and maximum risk need to be managed in accordance with the trader's risk tolerance and market assessment.

* Understanding these metrics is important for anyone involved in volatility-based trading strategies. The 'Expected Move' is an invaluable tool that provides a forecast of how much a stock's price might swing, positively or negatively, around its earnings announcement. This insight is essential for options traders, allowing them to gauge the potential risk and reward of their positions. Read more about it here: Understanding and calculating the expected move of a stock etf index

Moreover, the 'Implied Volatility Rank' (IVR) offers a snapshot of current volatility expectations in comparison to historical volatility over the last year. This ranking helps in identifying whether the market's current expectations are unusually high or low.

In addition to the Expected Move and Implied Volatility Rank, it’s also crucial to understand the concepts of ‘Implied Volatility’ and ‘Historical Volatility’. Implied Volatility (IV) is a measure of the market’s expectation of future volatility, derived from the prices of options on the stock. On the other hand, Historical Volatility (HV) measures the actual volatility of the stock in the past.

The relationship between these two types of volatility can serve as a valuable indicator for options traders. When IV is significantly higher than HV, it suggests that the market is expecting a larger price swing in the future, which could make options more expensive. Conversely, when IV is lower than HV, it could indicate that options are relatively cheap. Some traders use this IV-to-HV ratio as a signal for when to buy or sell options premium, adding another layer of sophistication to their trading strategies.

** A crucial application of the expected move in options trading is evident in strategies such as iron condors and strangles, particularly when these are implemented through short selling. In these strategies, the expected move serves as a pivotal benchmark for setting the boundaries of the trade. For instance, in the case of a short iron condor, traders typically position the short legs of the condor just outside the expected move range. This strategic placement enhances the probability of the stock price remaining within the range, thereby increasing the chances of the trade's success. Similarly, when setting up a short strangle, traders often choose strike prices that lie beyond the expected move. This ensures that the stock has to make a significantly larger move than the market anticipates to challenge the position, thus leveraging the expected move to mitigate risk and optimize the success rate. Utilizing the expected move in this manner allows traders to align their strategies with market expectations, fine-tuning their approach to volatility and price movements.

In this report, the calculation of the expected move for each stock and index is based on a refined approach, building upon the concepts outlined in our previous article. Traditionally, the expected move can be estimated by calculating the price of an at-the-money (ATM) straddle for the expiration date immediately following the event of interest. However, in this analysis, we've adopted a variation to enhance the accuracy of our predictions.

Our method involves a blend of 60% of the price of the ATM straddle and 40% of the price of a strangle that is one strike away from the ATM position. This hybrid approach allows us to closely mirror the expected move as indicated by the implied volatility (IV), offering a more nuanced and precise estimation. By utilizing this simplified yet effective method, we are able to provide an expected move calculation that not only resonates with the underlying market sentiments but also equips traders with a practical tool for their volatility-based strategies.

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This article may or may not have been enriched with the support of advanced AI technology, including OpenAI's ChatGPT and/or other similar platforms. The initial setup, research and final proofing are done by the author.

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