Wednesday, November 3, 2010

ITT Education (ESI) - Time Spread Opportunity

ESI is trading $61.69, down 5.4% with IV30™ up 2.6%. The LIVEVOL™ Pro Summary is below.


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Second one of this flavor today...

The stock just came up on a real-time custom scan. This one hunts for calendar spreads between the front two months.

Custom Scan Details
Stock Price >= $5
Sigma1 - Sigma2 >= 8
Average Option Volume >= 1,000
Industry != Bio-tech
Days After Earnings >=5 <=70
Sigma1, Sigma2 >= 1

The snapshot of the scan is included (below) in case you want to build it yourself in Livevol Pro™.

The goal with this scan is to identify back months that are cheaper than the front by at least 8 vol points. I'm also looking for a reasonable amount of liquidity in the options (thus the minimum average option volume), want to avoid bio-techs (and their crazy vol) and make sure I'm not selling elevated front month vol simply because earnings are approaching.

Looking to the Skew Tab (below), we can see the elevated vol in the front month (red line) relative to the second month (yellow line).

Note the vol difference between the front two months. I've highlighted a strangle, but the entire term structure is clearly priced with front > back.

Now we can turn to the Charts Tab (below). The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

This stock can move a lot. It's an expensive stock with pretty high vol. This makes for expensive options and a substantive amount of risk.

Finally, let's look to the Options Tab (below).

We can see Nov vol is priced at ~62.5 and Dec at about 55.

Potential Trades to Analyze
1. Strangle calendar: Sell Nov 55/67.5, Buy Dec 55/67.5. The fair value for the Dec 67.5 calls using 51 vol is $2.31 (note there is no bid there yet on max wide markets). This calendar would pay ~$4.70, sell ~$2.05 so a net debit of ~2.65. Buying 55 vol (ish) selling 65 vol (ish).

2. The strikes don't have to be even, putting on more risk could sell a closer to the money strangle and buy further OTM for a net even (ish) trade.

3. The opposite of #2 above. If you feel like a move is coming, sell further OTM front and buy closer to the money back. This allows a bit of wiggle room for the stock to move but is more expensive.

This is trade analysis, not a recommendation.

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