Thursday, June 18, 2015

TWTR - Opening #0 (Position Update)

Jun 19

Analysis

I am going to track the performance of a different hedging technique around stock. This technique is documented from the same text that wrote Stocks, Options, and Collars.

A traditional collar relies on the movement of stock that during more volatile price action creates substantial payoffs for the OTM put hedge. With stocks that have periods of volatility or have wider swings, this is has the potential to work well. (See AAPL hedge)

Canadian registered accounts are not allowed to trade short combinations of options such as the put spread or the butterfly. These accounts are only allowed to have short calls and long puts against a stock position, though synthetically stock + short call is the same as a short naked put -- stupid huh?

Stocks that are lower priced in general tend to have lower volatility and periods of smaller swings in price. Compare a stock like MSFT to AAPL or GOOGL or PCLN. The statistical range of price movement is smaller for lower priced highly liquid stocks.

Because of the OTM nature of the put, the plain collar is less effective with these types of underlying as larger moves come infrequently, if at all.

Instead, I can offset the cost of the long put into a butterfly (a ratio spread) where the buying one put is offset by selling two puts and a OTM tail to reduce margin.

The key is to strategically place the center strike of the butterfly in the statistical range of the stock movement (EM or 1 SD for a given DTE) and buy a higher delta put, usually ATM. The difference between the plain collar is that the total protection of the position is limited to the short put strike. With a strategic placement of the short position, we can attempt to be statistically covering the price movement.

This structure is such that even a small movement in price picks up delta as the long put is usually ATM. An OTM of the money call is still sold creating the equivalent of synthetic vertical spread. 

However, as the position is a butterfly the width of the strikes and time to expiration affects the performance prior to expiration. For this reason, I am going to limit the hedging to 30DTE or less so I am in the maximum range for theta decay.

As stock price movement is random, I rely on the statistical intervals or expected move to define overall risk. This range will expand and contract as per volatility. A 1 SD strike means that the outside the boundary price will enter only 16% of the time. 

The goal is the same, hold the stock position while using the collar to capture value and purchase more stock on downward price moves.



Opening Trade

A stock that has potential to trade like this is Twitter (TWTR). TWTR is now at the near of its all time low since IPO. This would seem to be a good time to enter a long position. Price of stock is low and yet can enough movement that this strategy should be profitable.

EM 34-38 @ 21 DTE (Jul 10'), IVR 22. I am going to place the butterfly at 34 and sell the call at 39.

There are two parts to this trade:

1) Stock
+100 shares TWTR @ 36.19

2) Hedge (net +0.03 debit)
+1/c ATM Jul 10' 36 - 34 - 32 Put fly = +0.43
- 1/c Jul 10' 39 Call = -0.40

Net Position Cost: 3622

We will monitor the value of the hedge, the butterfly and short call, looking to sell it out for greater than 0.03

Note: Earnings are between Jul 27-31.