Enis previewed Restoration Hardware’s earning event last week and looked at some hypothetical trades that all looked to take advantage of elevated levels of implied volatility. With the event come and gone and the stock now near 100 I wanted to circle back and look at exactly what implied vol did following and what that meant for the trades. To recap, here were the trades and the reasoning behind them:
Hypothetical Trades: Here are a few trade ideas into the print depending on your directional view:
(Note that they are all butterflies given the high level of implied volatility relative to realized volatility over the past 6 months, so be careful with bid/offer if you look to execute these trades.)
Bullish: Apr 90/100/110 call fly for $3.20
This structure targets the all time highs with an in-the-money fly that reduces premium risk as much as possible.
Neutral: Apr 85/95/105 call fly for $2.80
This is playing for a range bound stock with a decent payout of the stock is unchanged to slightly higher following the event.
Bearish: Apr 90/80/70 put fly for $1.75
This structure looks for a possible break of the rising 200 day moving average with a defined risk trade. If you’re looking for pure protection, you can buy the Apr 90/80 put spread for around $2.40
The Bearish trade was the only one out of the money and essentially looked to offset the high implied volatility by selling two of the 80 puts, rather than the put spread which was about .65 more without the sale of two 80 puts. This trade is likely a total loss if held and one could salvage about .35 of it if closed now.
The Bullish and the Neutral trades are both winners with the stock at $99. Both started as in-the-money flies with the extra advantage of not only good risk reward if the stock was within their range after the event, but also the high implied volatility that would add profits to those structures as they are net short vol. So what happened to vol?
[caption id="attachment_52352" align="aligncenter" width="738"]
3 month $RH IV30 vs HV30 from LiveVol Pro[/caption]
It was in the mid 40’s into the event and is int he low 30’s after. On a percentage basis that is significant and the end result is that both the Neutral and the Bullish in-the-money trades made money.
With the stock at $99 the Bullish Apr 90/100/110 call fly that was $3.20 into the event (for an effective entry in the stock of 93.20 with only 3.20 of downside risk) is now worth about 5.25 and has potential for much greater gains if the stock settles in near the $100 level. Intrinsically the trade is worth $9 here so that extrinsic 3.75 in value that has yet to come in is what will buffer any moves away from the $100 strike between now and April expiration. We like to use that intrinsic/extrinsic value to determine a soft stop if the stock does indeed start to move. As long as it doesn’t violate the range enough to put all of more of that extrinsic value at risk that trade is worth holding as long as possible.
The Neutral Apr 85/95/105 call fly that was $2.80 into the event is now worth about 4.20 while its intrinsic value is around $6. That one needs to be kept on a shorter leash than the 90/100/110 as any moves higher above $100 start to hit that intrinsic/extrinsic risk level faster. However, if the stock starts to grind lower towards $95 that trade has the potential to be worth up to $10 as well. But it has more delta risk (short 45 deltas) than the 90/100/110 which is practically delta neutral (long 2-3 deltas).
The key here is that if you’re willing to do a multi leg trade into an event with high implied volatility there are multiple ways to win. The Bearish trade was simply directional but both the Neutral and Bullish were essentially range trades (synthetic condors) with the only difference being where the center strike was placed.