FDX reported earnings this morning and the stock is down more than 5%. Our structure from yesterday is a slight winner here with risk to the downside and incremental profits higher and a max gain with the stock at 105. We thought it was a good trade to go over as we actually considered a number of structures yesterday before settling on the in-the-money put fly. This is a structure that has been working very well lately and the question is whether we went to the well too often when there could have been better structures out there?
To recap, the in-the-money fly is one in which we are usually calling for a slight move up or down in a stock, and putting a structure on for a debit that is actually short premium in that the debit is trading for less than what that structure is intrinsically worth at the time. To illustrate this, let’s look at the trade from yesterday:
Trade: FDX (106.79) Bought the Apr 110/105/100 Put Fly for $1.35
- Bought 1 Apr 110 put for 4.62
- Sold 2 Apr 105 puts at 4.01 total (2 and 2.01 respectively)
- Bought 1 April 100 put for 0.74
Notice that the trade cost 1.35, yet intrinsically it was worth 3.21 at that moment. That 1.86 difference is the premium we are short in the structure. What that means is that if the stock closed at 106.79 on expiration that trade would be worth 3.21. With the stock at 110 or 100 it would be worthless and at 105 it would be worth 5 dollars. Because the trade is short premium it benefits from collapsing vol, decay and other premium killing things that happen over time or following an event. However, big moves either way are its enemy.
So how’s the trade look now? With the stock at 100.85 the trade is worth about 1.45. What’s different now though, is that instead of short premium, slightly bearish as the position was when we did it, it’s now long premium, slightly bullish:
- yesterday with stock at 106.79 structure is 1.35 but intrinsically worth 3.21 and best scenario is stock down to 105
- today with stock at 100.85 structure us 1.45 but intrinsically only worth 0.85 with best scenario higher to 105
So why did we go with this structure and what other structures did we consider? Looking at the chart we thought that a down move to FDX’s 50 day moving average was a good probability. The main risk we considered on a bearish bet was good earnings and a move to 110 in the stock. This scenario didn’t concern us much because we felt an earnings move up to its highs would have a strong possibility of finding sellers that could push the stock back down. The day(s) after FDX’s recent earnings have not been kind to the stock as it’s sold off 5 of the past 6 (now 7) times, at least temporarily, in the days after:
[caption id="attachment_23886" align="aligncenter" width="688"]
2 yr FDX chart from LiveVol Pro[/caption]
Centering the structure at 105 when we thought 103.50 was a good possibility was a compromise that had to be made due to the 5 dollar wide strikes. If FDX had a 102.50 strike we may have strongly considered centering a trade at that level. In either case the stock made a move greater than what we expected. The fact that that happened and the trade is still not a loss shows the power of that structure’s range of profitability.
So, we got the direction of the move correct, but the magnitude of the move wrong. This morning we went over some of the other structures we considered to see how they would have fared.
One of the structures we most strongly considered was selling the Apr 105/110 call spread together with selling the Apr 100/95 put spread. This is a similar structure in that it is bearish, but with the thinking that a down move would still stay within a certain range. When we looked at this trade yesterday it could have been done for about a 2.80 credit. Today that trade is worth about 1.80 or a 1 dollar profit. This structure would have done better due to it being more bearish than the fly with a lower sweet spot by a few dollars. The other trade we looked at was selling the Apr 105/110 put call spread outright at about 2.30, (today about 0.60) which carried more risk but was the most outright bearish of the structures. In that case the break-even was tighter on the upside from the other structures but could get its max gain on an out-sized move below 105 or even 103.50 whereas the fly needed the stock to stop on a down move at 105 to get its max gain.
In hindsight, Enis really liked the outright call spread sale due to the fact we thought the move below 105 was such a strong possibility. I’m not so sure about it because I don’t love the risk/reward of possibly losing 2.70 on a breakout above 110 for the chance at 2.30 to the downside, but again, in hindsight, this was the best possible win of the trades considered.
So now, with the Fly we’re looking for any sort of rally in the stock and we’d likely take it off. A move to 103.50 in the coming days would be a a great chance for a profitable exit. If FDX continues to drift lower and breaks down below 100 then the fly is in trouble.