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Hawk’s Vision

Forget Direction! Trading Consolidation via Long Volatility Strategies

Jul 5, 2012

One of the many advantages of trading options is that you do not need to pick a direction to have a winning trade, you can use indicators and statistics to set up high probability strategies that are Delta Neutral.Each week in the Options Hunter Newsletter I put out on Sundays, one of the 7 trades is always a volatility trade, named “Volatility Stalker”.  Each of the last two weeks I have highlighted former momentum names that were trading in tight ranges, and odds were there would be an upcoming breakout or breakdown.  Both trades worked perfectly and the $75/month for the newsletter is an absolute bargain considering I put in about 20 hours of work into the newsletter per month, so basically paid $4/hour.I will screen-print each of the trades below to end this blog, but wanted to first discuss what I look for to find these trades.  A few critera to finding candidates for a long volatility strategy (keeping simple via long straddles and strangles):

  • Liquid Options – My Main Watch-list is 510 Stocks that Trade 1,500+ Options Per Day, and for this prefer ones that trade 5,000+ per day
  • >$50 Stock Price and Average Volume > 500,000 (This Alone Leaves 308 Stocks)
  • Short Float > 10% – Tend to See Stronger Breakouts/Breakdowns
  • Battleground Stocks – Stocks with Skeptics Whether it Be Due to High Valuation Metrics or Other Reasons
  • RSI (14) Between 30 and 60 – Do Not Want Oversold/Overbought Stocks – Want Consolidating Stocks
  • ATR and Bollinger Band Width – Both Can Be Charted on Stockcharts.com – Look for Stocks Near 6 Month Lows on these Indicators
  • Browsing Charts – Simple “Eye-Test” Looking for Stocks Trapped in Tight Ranges Between Key Levels
  • IV30 Near 6 Month Low – Looking to be a Net Buyer of Options, Look for Cheap IV30 Relative to 6 Month Range, or 1 Year Range
  • Catalyst – Upcoming Events are Always + for Volatile Moves, Although Generally Priced In When Announced, so Need to Act Fast
There are a few other relationships to look at with IV vs. HV, Skew, and Available Strikes, but the above should be a great starting point for anyone looking to make one of these trades.
The two trades below are from the last two weeks newsletters, the Chipotle (CMG) trade gained 65% in 3 Days and the Netflix (NFLX) trade gained 65% in 3 Days.  As non-directional trades, there is relatively less risk with the trade if you set up a max-length of holding to avoid decay, so this type  of gain in 3 days for a volatility trade is a strong win.
A couple names that currently fit much of the above criteria are Salesforce.com (CRM), Linked-In (LNKD), Wynn Resorts (WYNN), Buffalo Wild Wings (BWLD), and F-5 (FFIV).
As a trade-idea take a look at Wynn Resorts (WYNN) with shares in this $97.5/4105 range for weeks now and sitting near major support of its 200 week EMA, also forming a bear flag on the weekly with the next Fibonacci support at $87.40.  A rebound move could see shares reach the $115/$120 area.  WYNN trades 21.5X trailing earnings, PEG 1.34, and 39.4X cash flow, still over-valued but nowhere near as rich as shares were earlier this year, concerns lie with the slowdown in Macau revenues recently confirmed by the data.  UBS has a $165 target on shares, reiterated Buy on 5-8-12, so the Street sees value.  WYNN has not confirmed its next earnings date, but looking at the IV of the options it likely falls in August.
WYNN trades more than 15,000 options per day, and RSI currently at 46.7, fitting most of the criteria, except it only has 5% of its float short, but a large float.  WYNN’s IV30 at 37.6% is in the 14th percentile of the 1 year range, and near the lowest in a month with a 35% to 48% range.
The key here is WYNN’s Bollinger Band Width is at a 1 year low, and ATR also near a 1 year low.
WYNN currently trades at $101.82 and the August $105/$100 Strangle Trades at $8.25, a Profit Zone with Shares Below $91.75 or Above $113.25, a move that looks achievable when looking at the chart, and IV also should be bid up into earnings.  WYNN also trades weekly options, and experienced traders can sell weekly strangles against the long strangle to lessen the net outlay, and keeping a close eye on the official earnings date release.
*** This is not a trade recommendation, do you own due diligence.  It is presented for educational purposes as an example of how to utilize long volatility strategies in consolidating stocks.

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