Weekly Earnings Commentary
We are firmly in the doldrums of earnings season for the next few weeks, but that doesn’t mean we will not be presented with an opportunity or two each week. While last week was slow, this week picks up, slightly with a potential opportunity in DocuSign (DOCU).
While I could really care less about the fundamental aspects of the company and the upcoming earnings announcement, the high implied volatility (IV) piques my interest. Though I am not a fan of chasing high IV stocks, I am a fan of highly liquid stocks that have highly inflated premium around earnings. And with an IV of 106.5%, the upcoming binary event in DOCU offers an interesting trading opportunity, especially when we can create a range of 25 points on a $58 stock, a total range of 40%. But we must understand that a range this large is offered for a reason and as always, if a trade is taken, position size should be of the utmost importance.
Our overall return is 49.2% – as I stated last week, certainly nothing to write home about, but also no complaints as we thankfully sit in positive territory during what has been an incredibly challenging market for all participants over the past year.
If you have any questions, please do not hesitate to email me at andy@cabotwealth.com.
Weekly Watchlist
- Ciena (CIEN)
- DocuSign (DOCU)
Top Earnings Options Plays
Here are a few top earnings options plays for this week (6/5-6/9) if you are so inclined:
Images Courtesy of Slope of Hope
Trade Ideas for Next Week
As a reminder, you will quickly begin to notice I tend to stick with stocks that have high liquidity as it’s far easier to get in and out of a trade. Medium liquidity offers tradable options, but sometimes the bid-ask spread is wider, which means a greater potential for more price adjustments, making entering and exiting a trade difficult from time to time. Remember, there are roughly 3,200 tradable stocks with options and 11% have medium liquidity while only 3% have what’s considered high liquidity.
Potential Trade Ideas for This Week
DocuSign (DOCU)
DocuSign (DOCU) is due to announce earnings Thursday after the closing bell.
The stock is currently trading for 57.47.
- IV Rank: 28.5
- IV: 106.5%
Expected Move for the June 16, 2023, Expiration Cycle: 49 to 66
Knowing the expected range, I want to place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 49 to 66.
If we look at the call side of DOCU for the June 16, 2023, expiration, we can see that selling the 70 call strike offers an 87.90% probability of success. The 70 call strike sits just above the expected move, or 66.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 49. The 45 put, with an 87.69% probability of success, works.
We can create a trade with a nice probability of success if DOCU stays within the 25-point range, or between the 70 call strike and the 45 put strike. Our probability of success on the trade is 87.90% on the upside and 87.69% on the downside.
Moreover, we have a 21.8% cushion to the upside and a 21.7% margin of error to the downside.
If we look at the earnings reactions since 6/7/2018 we can see that there have been only a few breaches of 20% to the upside or downside after an earnings announcement.
As a result, an iron condor looks enticing in DOCU this week. But don’t be fooled by the large percentage-based range. While enticing, there is a reason why the margin of error is so large on the DOCU iron condor.
If one wanted to make a trade, below are the potential strikes that make the most sense or are at least a starting point for a trade.
Here is a potential trade:
Simultaneously:
Sell to open DOCU June 16, 2023, 70 calls
Buy to open DOCU June 16, 2023, 75 calls
Sell to open DOCU June 16, 2023, 45 puts
Buy to open DOCU June 16, 2023, 40 puts for roughly $0.78 or $78 per iron condor.
Our margin requirement would be roughly $422 per iron condor. Again, the goal of selling the DOCU iron condor is to have the underlying stock stay below the 70 call strike and above the 45 put strike immediately after DOCU earnings are announced.
Here are the parameters for this trade:
- The probability of success – 87.90% (call side) and 87.69% (put side)
- The maximum return on the trade is the credit of $0.78, or $78 per iron condor
- Max return: 18.5% (based on $422 margin per iron condor)
- Break-even level: 70.78 – 44.22.
As always, if you have any questions, please do not hesitate to email me at andy@cabotwealth.com.
The next Cabot Options Institute – Earnings Trader issue will be published on June 12, 2023.