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Options Trading Newsletter - Issue #136 LEVERAGE... (OPTIONS TODAY - EARNINGS PLAY - BUTTERFLY ON INTC )
Leverage... [Option Today - Earnings Play - Butterfly on INTC]
LEVERAGE… [Options Today - EARNINGS PLAY - BUTTERFLY ON INTC]
The concept of “Leverage” is not new. All form of “Leverage” involves actions that results in amplified outcome. One common form of “Leverage” involves using other people's money to buy assets and I am sure most of you have read or come across Robert Kyosaki’s book Rich Dad Poor Dad, where he explains the concept of using borrowing to buy property to generate cash flows.
Going back to the results of “Amplified Outcome”, think of the things you are doing right now, what are the things you need to do or tools you need to use to amplify the outcome. List the outcome or objectives and then list down the potential amplifiers. Then work on how to get or implement the amplifiers and see if you can get better outcomes. Many a times, we may already know these “amplifiers” but we do not really use or implement them. The only way is really set it out as a plan and then implement.
Everyone need to use “Leverage”, even companies like Netflix uses leverage by getting rights of good movies and stream them on their channel, instead of own produced shows. One good Drama to watch and understand “Leverage” and “Planning” is this Japanese drama “Trillion Game”. I’m not going to be a spoiler, go watch for yourself. Why do you think Netflix gained 12%+ on its recent earnings? It’s just because they know how to use “Leverage” to amplify results. By mastering the use of “Leverage”, you can accomplish tasks more efficiently and achieve greater results. 😅
“Give me a lever long enough and a fulcrum on which to place it, and I shall move the world - Archimedes”
SPX is now put on a spot if it should continue the downtrend or take support and bounce. As it has 2 support levels, one which was the previous lows of early October and the other the daily 200MA, there is a chance of a bounce before it decides if it wants to test 4100 level.
The Fed Chair J.Powell has basically given indication that no further hikes for now but rates are expected to stay high for longer until the economic data sizzles down for their fight against inflation is affirmed. The economy have to proof their pain first before rates are going to come down.
Market is staying cautious and VIX has spiked above the 20 level. Until it comes back down, its not time to go all in and be bullish as market does not seem to have bottomed. VIX would probably need to go up higher and hit 30s before market sees any capitulation or major reversal. So stay light on your longs for now.
Trade range for the week is 4100 to 4350.
As expected, GLD hit resistance at 185 and went below the previous high in July. We could see it going high again if flight to safety is required depending on how the Middle East situation plays out. For now, it could trade in range between 180 to 186. If GLD stays put or goes higher by a lot today, we might restart our strangle trade again.
NDX is down 2.9% for the week. It does not look good as the earnings results have started to be mixed. Last week NFLX was up 12.7% while TSLA was down 15.6%.
As it is now, NDX seem to be holding support at current levels. As like SPX, it might bounce up slightly before breaking support to go down lower to 13700 level on the downside.
This week’s earnings will determine the sentiment with MSFT and GOOGL due on Tuesday after market close. META on Wednesday and AMZN on Thursday. If we start to miss earnings for the remaining magnificent 7 this week, that could weight down the market to the downside.
Trading range for the week is between 14100 to 15000.
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HANG SENG INDEX (17172)
HSI did not go above 18000 and continued to slide for the week. As is there is no major catalyst to see HSI going higher, even though China has shown growth in GDP it does not give much impact so far.
The lower support now at 16800 and resistance at 17600.
OPTIONS TODAY [EARNINGS PLAY - BUTTERFLY ON INTC]
There are many ways to profit from earnings. But there is one thing we can be certain of is that, IV will tend to come down after earnings. That’s why people tend to sell options pre-earnings and wait for the IV to fall post earnings. (ie. Selling at a gigher price and buying back at a lower price due to the IV squeeze).
But there’s a catch, because you do not know which direction it will go, you may get caught if you sell into the wrong side. Of course, some people sell options both ways like using a strangle and try to benefit when IV reduces post earnings, but this works well if the price movement falls within the range of your short put/call. You could also get caught one side if the fall in IV and profit from one side does not compensate enough for the directional movement to the other side.
There’s another option strategy which can be used to play earnings and this is by using a Debit Butterfly. Basically a Butterfly is nothing more than a Bull Call Spread plus a Bear Call Spread with the same short strike and same width on both side. If you are doing it with a Put then a Bull Put Spread and Bear Put Spread. Technically, it does not matter if you are doing it via a Call or Put, the more important thing to decide is where do you expect the stock price to land and that’s the place you sell 2 contract and then determine the same width wings both side.
Butterfly is a longshot strategy which provides a low probability but high return ratio, of at least 1:4/5. However, getting to the max profit would mean that the stock price falls within the range of your wings and continues to stay there till expiry. Hence, it is quite difficult to go all the way and we would normally exit the trade if we get anything above 50% return. Sometimes, we can also benefit if the trade is slightly out of the price range provided we still have some time to expiry.
Earnings Play - INTC Debit Butterfly
INTC is going into earnings on Thursday after market. INTC is currently trading at $34.92 and INTC is generally on uptrend since February 23. It hit a high of $40 in September before retracing following the overall market decline.
For an indication of which direction INTC will go on this earnings, we will refer to the Zacks Ranking and Earnings Surprise Prediction (ESP). A high ranking would be bullish on the stock and a positive ESP would mean a positive surprise on earnings.
Once above is determined, we have a bullish directional play indicated for INTC. The next step is to determine where will INTC price land after earnings. For this we can just use the Expected Move as the indication. Expected Move for 27 October expiry is +/-$2.39. Earnings is on Thursday 28 October. As we are bullish, we just add this to the current price ($34.92+$2.39 = $37.31).
So we could theoretically pick $37 as the short strike. And then set the wings. The wider the wings, the bigger the probability of trade, but that will also result in a higher entry cost. As our target is to do a low cost high probability trade, we would not normally enter into a highly expensive trade but to keep it low. Generally, I would keep such trades to below $0.50.
Example would be like below.
Sell 2 Call at $37 strike
Buy 1 Call at $36 strike
Buy 1 Call at $28 strike.
The trade entry cost $0.13 with a max profit of $0.87.
If price falls within the range (upper/lower boundary +/- trade cost)(“Range”), the trade will go into profits. If the trade is slightly out of the range after earnings but we still have some days till expiry, it might also show a small profit. If we do not see possibility of it going back to range, we may exit with breakeven or small profit. The max profit will only be achieved on expiry and if it is within the Range. But we would normally close the trade well before with anything above 25% profit. If it is within Range, we could wait for the profits to slowly increase or put in a GTC order to exit. Risk is it may go out of range anytime and the trade may turn from profit to loss immediately. Advice is don’t try to wait for a max profit, take any profit you get as this is a low probability high return trade.
For our INTC trade, as we still have 4 days before earnings and looking at the market condition, we do not think it will move the full expected move and probably only slightly above current price. So we will pick, the short strike at $35.5 and increase the width to $1.5 each side, buying the $34 Call and $37 Call. That way, if INTC moves the full expected move, it will still fall within the profit zone but at same time, we also cover the downside if INTC moves below current price. However as the width is bigger the cost of trade goes to $0.26 and max profit at $1.24.
(final entry price to be decided at entry point again, we will post on Notes)
Earnings Trade Tips
We can check past quarters earnings movement before and after earnings announcement on the Thinkorswim Analysis Earnings Tab.
Close the trade before expiry if the price falls within the profit range. If it falls far outside the profit range, there is no action required. You may also close the trade if it goes outside the range to salvage any value left after trade commission.
Butterflies are cheap entry trades with high return ratios. We do not need to be exactly right on our price targets and try to benefit if we are able to catch the price into our price net. It is typically good to be used in earnings play
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