Target Corporation (NYSE:TGT) : The Marvelous Volatility Option Trade After Earnings
Date Published: 2018-08-01
DisclaimerThe results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.
LEDEThere is a marvelous pattern in Target Corporation (NYSE:TGT) right after an earnings miss that could be a great back-test to earmark in case we see a down market in the coming month, especially in the retail sector which is always on pins and needles for evidence of the oncoming Amazon apocalypse.
This is a slightly advanced option trade that bets on volatility for a period that starts one-day after earnings and lasts for the 6 calendar days to follow, that has been a winner for the last 3 years with one losing trade.
But, Marvelous, Really?We use the world 'marvelous' not because of the high returns, but rather the risk to return ratio -- it has been breathtaking. Let's take a look.
Target Corporation (NYSE:TGT) EarningsIn Target Corporation, if the move off of earnings was a 5% drop or more, if we waited one-day after earnings and then back-tested going long an one-week strangle (using two-week options), the results were quite strong. This trade opens one-day after earnings were announced to try to find a stock that moves a lot after the earnings announcement.
Here is the timing set-up around earnings:
Rules* Open the long out-of-the-money (40 delta) strangle one-calendar day after earnings if and only if the stock is down 5% or more.
* Close the strangle 7 calendar days after earnings.
* Use the options closest to 14 days from expiration (but more than 7 days).
This is a straight down the middle volatility bet -- this trade wins if the stock is volatile the week following earnings and it will stand to lose if the stock is not volatile. This is not a silver bullet -- it's a trade that needs to be carefully examined.
But, this is a stock direction neutral strategy, which is to say, it wins if the stock moves up or down -- it just has to move.
RISK CONTROLSince blindly owning volatility can be a quick way to lose in the option market, we will apply a tight risk control to this analysis as well. We will add a 40% stop loss and a 40% limit gain.
In English, at the close of every trading day, if the strangle is up 40% from the price at the start of the trade, it gets sold for a profit. If it is down 40%, it gets sold for a loss. This also has the benefit of taking profits if there is volatility early in the week rather than waiting to close 7-days later.
Another risk reducing move we made was to use 14-day options and only hold them for 7-days so the trade doesn't suffer from total premium decay.
RESULTSIf we bought the out-of-the-money (40 delta) strangle in Target Corporation (NYSE:TGT) over the last three-years but only held it after earnings and after the stock dropped by 5% or more, we get these results:
The mechanics of the TradeMachine® Stock Option Backtester are that it uses end of day prices for every back-test entry and exit (every trigger).
We see a 216.3% return, testing this over the last 12 earnings dates in Target Corporation. That's a total of just 72 days (6 days for each earnings date, over 12 earnings dates).
Looking at AveragesThis is the 'marvelous' part:
The overall return was 114%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 25% over 6-days.
➡ The average return per winning trade was over 6-days.
➡ The return for the losing trade was over 6-days.
It's that average win percent to average loss % that caught our eye.
MOVING FORWARDTrade with knowledge. Take a reasonable idea, test it, and apply lessons learned.
Tap Here, See for Yourself
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.