Wednesday, March 2, 2011

Barnes & Noble (BKS) - Calendar Spread on Company Uncertainty

BKS is trading $12.61, down 0.7% with IV30™ up 1.1%. The LIVEVOL™ Pro Summary is below.


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Barnes & Noble, Inc. (Barnes & Noble) is a bookseller. The Company is a content, commerce and technology company that provides customers access to books, magazines, newspapers and other content across its multi-channel distribution platform.

Here's a quick snippet from the Canadian Press after BKS earnings a couple of weeks ago:
Book seller Barnes & Noble's third-quarter revenue rose, but its net income fell 25 per cent as it continued to invest in its online operations and Nook e-readers, the company said Tuesday.

The largest U.S. traditional book store chain also said it was suspending its quarterly dividend, and it doesn't plan to forecast its fourth-quarter or full-year earnings due to the effect of last week's bankruptcy filing by its chief rival, Borders Group Inc.

Yikes... Dividend suspended and no projections... The next earnings cycle is due out late Jun-early Jul. How convenient that the third month listed is the Jul options.

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

Custom Scan Details
Stock Price >= $5
Sigma2 - Sigma3 >= 7
Average Option Volume >= 1,000
Industry != Bio-tech
Days After Earnings >=5 <=50
Sigma2, Sigma3 >= 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 third months that are cheaper than the second by at least 7 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 second month (yellow line) relative to the third month (green line). I also note that the front month (red line) is elevated to both of the others.

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).

Most notable here is the giant drop from earnings a couple of weeks ago. BKS peaked at ~$18.69 a few days before the release, and is now down in the $12 range.

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

Potential Trades to Analyze
So the question here is, will the company stand by their press release and not provide guidance? If so, the vol in Jul options could increase dramatically as we approach the earnings date. That vol increase will reflect growing uncertainty. Owning the third month at a discount seems like a reasonable trade to analyze -- the question is, how does one do that?

1. Calendar spread April and July:
Sell the Apr 12/13 strangle @ $1.40 (~54 vol).
Buy the Jul 12/13 strangle for $2.50 (~49 vol).
A net debit of $1.10. One risk here is that BKS moves abruptly outside of the ($12, $13) range before Apr expo. That could kill the vol in the July strikes and net a loss.

2. Calendar spread Mar and July:
2a. Sell the Mar 12/13 strangle @ $0.75 (~59 vol).
Buy the Jul 12/13 strangle for $2.50 (~49 vol).
The risk here is similar to #1, but the stock has to stay range bound for one less month. The trade-off of course is that the net debit is $1.75 as opposed to $1.10.
2b. An extension to this trade, if it works out through Mar expo, is to then sell the Apr 12/13 strangle. So, sell twice as many options are purchased but never be naked short.

3. Buy July naked:
It's reasonable to analyze simply purchasing July options. The question then is, when? If BKS stock sits still and there is no news (as the company claims), then the Jul options will get cheaper as time decays them.

4. An odd ball: Buy Mar naked.
Yup -- it's also interesting to analyze purchasing the elevated vol in Mar and bet on a BKS stock move of a couple bucks in the next few weeks.

This is trade analysis, not a recommendation.

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