I was looking at other possible trade setups last evening and noticed that P (Pandora Media) was brushing the 60 IV rank which in the neighbourhood of being ripe for a put credit spread, so I thought I would run the numbers to see if it was ripe.
Two primary criteria for even considering a stock include being very liquid (high volume, over 2 million) in both the stock and option volume. Options I like to see 500 open interest or more in the strike ranges where I might choose to place a trade. I also like to see penny spread pricing (difference between the bid and ask) but up to 10 cents is not the end of the world, getting orders filled may take longer if I am picky about the price in those cases.
P fits the bill although the option spread is 5 to 10 cents.
The next thing to do is to run the historical price activity through the wringer.
| 40 Days | 35 Days | 30 Days | 25 Days | 20 Days | 15 Days | 10 Days | 5 Days | Combined |
| Strike | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate |
| 0% | 62.96% | 62.96% | 62.96% | 59.26% | 53.57% | 53.57% | 57.14% | 57.14% | 58.64% |
| -1% | 66.67% | 62.96% | 62.96% | 59.26% | 53.57% | 60.71% | 60.71% | 57.14% | 60.45% |
| -2% | 66.67% | 62.96% | 62.96% | 59.26% | 60.71% | 60.71% | 60.71% | 67.86% | 62.73% |
| -3% | 66.67% | 62.96% | 62.96% | 62.96% | 60.71% | 60.71% | 60.71% | 75.00% | 64.09% |
| -4% | 66.67% | 62.96% | 62.96% | 62.96% | 64.29% | 60.71% | 60.71% | 75.00% | 64.55% |
| -5% | 66.67% | 66.67% | 62.96% | 62.96% | 64.29% | 60.71% | 67.86% | 78.57% | 66.36% |
| -6% | 74.07% | 66.67% | 62.96% | 66.67% | 67.86% | 64.29% | 67.86% | 82.14% | 69.09% |
| -7% | 74.07% | 66.67% | 62.96% | 70.37% | 67.86% | 64.29% | 71.43% | 82.14% | 70.00% |
| -8% | 74.07% | 66.67% | 66.67% | 70.37% | 67.86% | 64.29% | 75.00% | 82.14% | 70.91% |
| -9% | 74.07% | 66.67% | 66.67% | 70.37% | 67.86% | 64.29% | 75.00% | 82.14% | 70.91% |
| -10% | 74.07% | 66.67% | 66.67% | 70.37% | 67.86% | 67.86% | 75.00% | 89.29% | 72.27% |
| -11% | 74.07% | 66.67% | 66.67% | 70.37% | 67.86% | 71.43% | 75.00% | 92.86% | 73.18% |
| -12% | 74.07% | 66.67% | 66.67% | 70.37% | 71.43% | 71.43% | 78.57% | 92.86% | 74.09% |
| -13% | 74.07% | 70.37% | 66.67% | 70.37% | 71.43% | 71.43% | 82.14% | 92.86% | 75.00% |
| -14% | 74.07% | 70.37% | 66.67% | 70.37% | 71.43% | 71.43% | 85.71% | 92.86% | 75.45% |
| -15% | 74.07% | 70.37% | 66.67% | 70.37% | 71.43% | 75.00% | 85.71% | 96.43% | 76.36% |
| -16% | 77.78% | 70.37% | 70.37% | 70.37% | 71.43% | 78.57% | 85.71% | 96.43% | 77.73% |
| -17% | 77.78% | 70.37% | 70.37% | 70.37% | 71.43% | 78.57% | 85.71% | 96.43% | 77.73% |
| -18% | 81.48% | 77.78% | 74.07% | 70.37% | 71.43% | 82.14% | 85.71% | 96.43% | 80.00% |
| -19% | 81.48% | 77.78% | 77.78% | 70.37% | 75.00% | 82.14% | 85.71% | 96.43% | 80.91% |
| -20% | 85.19% | 77.78% | 77.78% | 77.78% | 82.14% | 89.29% | 85.71% | 96.43% | 84.09% |
| -21% | 85.19% | 77.78% | 77.78% | 81.48% | 85.71% | 89.29% | 85.71% | 96.43% | 85.00% |
Well, not as good as I might have wanted as only the really short term trades are in any decent range. Seeing as this stock has weekly options I would look at the near week to see if there was any premium to sell in that 5 day area so with that in mind I looked at the November 22 options. These are actually the monthly options but in the last week, it amounts to the same thing and probably allows for higher open interest.
Quick note about this, if I already had a longer trade on I can add a different strike short term trade which serves to add a sort of diversification to the position and add a bit of profit or, if the current position is being tested (close to losing) it can also serve to offset some potential losses... tough to do that with a straight stock trade.
With the price today at $28.59, 11% lower would be $25.44... so I selected the 25/20 November 22 strikes to come up with a 40 cent credit. While the ROR is only 7.1%, that is for a trade that will only last three days, which is a very good daily return of 2.4%. I think that this would be one to keep an eye just for the weekly option trades, almost scalps in a sense as they are so short of duration.
The other option is to look at the longer term expiry options, out to 30 trading days or so, but the idea would be to only hold them for a shorter term, 10, 15 and 20 trading days, rather than through to expiry. This amounts to early profit taking. Here's a table showing the historical results:
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| 10 of 40 days | 15 of 40 days | 20 of 40 days | 10 of 30 days | 15 of 30 days | 20 of 30 days |
| Strike | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate | Win Rate |
| 0.00% | 55.56% | 59.26% | 62.96% | 48.15% | 51.85% | 55.56% |
| -1.00% | 59.26% | 59.26% | 66.67% | 51.85% | 55.56% | 55.56% |
| -2.00% | 66.67% | 59.26% | 66.67% | 55.56% | 55.56% | 59.26% |
| -3.00% | 70.37% | 59.26% | 66.67% | 55.56% | 59.26% | 59.26% |
| -4.00% | 70.37% | 62.96% | 66.67% | 59.26% | 66.67% | 62.96% |
| -5.00% | 70.37% | 62.96% | 66.67% | 66.67% | 70.37% | 62.96% |
| -6.00% | 70.37% | 66.67% | 66.67% | 66.67% | 74.07% | 66.67% |
| -7.00% | 74.07% | 66.67% | 66.67% | 70.37% | 74.07% | 70.37% |
| -8.00% | 74.07% | 66.67% | 70.37% | 70.37% | 77.78% | 70.37% |
| -9.00% | 74.07% | 70.37% | 70.37% | 74.07% | 81.48% | 70.37% |
| -10.00% | 74.07% | 70.37% | 74.07% | 81.48% | 81.48% | 81.48% |
| -11.00% | 74.07% | 70.37% | 74.07% | 81.48% | 81.48% | 81.48% |
| -12.00% | 74.07% | 74.07% | 77.78% | 92.59% | 85.19% | 81.48% |
| -13.00% | 77.78% | 74.07% | 77.78% | 92.59% | 88.89% | 81.48% |
| -14.00% | 77.78% | 77.78% | 77.78% | 96.30% | 88.89% | 81.48% |
| -15.00% | 81.48% | 81.48% | 81.48% | 96.30% | 88.89% | 81.48% |
| -16.00% | 85.19% | 85.19% | 81.48% | 96.30% | 88.89% | 85.19% |
| -17.00% | 88.89% | 88.89% | 81.48% | 96.30% | 88.89% | 85.19% |
| -18.00% | 88.89% | 92.59% | 81.48% | 96.30% | 88.89% | 85.19% |
| -19.00% | 88.89% | 92.59% | 81.48% | 96.30% | 92.59% | 85.19% |
| -20.00% | 92.59% | 92.59% | 92.59% | 96.30% | 92.59% | 85.19% |
| -21.00% | 96.30% | 92.59% | 96.30% | 96.30% | 92.59% | 88.89% |
The table represents trades that were placed a certain percentage lower than the trading price at the time 40 days and 30 days from expiry and shows how low the price was relative to the starting price at 10, 15 and 20 days later. The first 10 days of a 30 day to expiry period seems to be the sweet spot as in over 92% of the trades the price remains higher than the 12% lower strike and almost 67% of the time it remained higher than the 5% lower strike.
The downside is that the premium would have to be priced very high, perhaps from a very high IV ranking in order to see it drop fast enough after the trade was placed to be able to close the trade for a profit. This sort of trade relies on the fast collapse of volatility and is riskier than I would take right now... the IV rank of 60 is not high enough and the actual price action is not low enough.
On the chart, the blue line is the 8 day moving average and I like to use it as a go / no go indicator as the price rides below it for at least a day or two before entering a trade. Typically there is a spike in premium at this time and entering at a lower price allows a greater margin from the average price for the trade. This follows a rough mean reversion idea and I can get into standard deviations, but won't at this point.
All of my tables assume that EVERY trade is entered regardless and while the lower entry idea results in somewhat better historical numbers it eliminates a lot of the possible profitable trades.
Jeff.
