Family Dollar (FDO) - Secret Sauce to Professional Trading: Earnings Vol Analysis/Preview

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Family Dollar (FDO) - Secret Sauce to Professional Trading: Earnings Vol Analysis/Preview

At the time of this post, FDO is trading 37.39, IV30ô is up 6% and earnings are tomorrow before the market opens (i.e. today is the last trading before earnings) The summary is below.





I’m often asked how pros do earnings analysis and trades using options - Often generating 50% returns in a day... Well, here’s the secret sauce... sort of...

The company has traded ~ 5,800 contracts today in the first two hours surpassing its total daily average option volume of 5,388. The Stats Tab and Day’s biggest trades snapshots are included (click either image to enlarge). For what it’s worth, the largest trades have been Apr 34 and Apr 36 put purchases.

A few things we probably know with earnings vol:

(1) Vol will rise into the event
(2) Vol will drop after the event
(3) The stock will move that day more than average

What we don’t know:
Will the underlying move be large enough to make the vol a purchase... Or, put another way, since the vol is most likely going to collapse after the announcement, shouldn’t it be an auto sale?

Let’s use FDO as our case study, it has earnings tomorrow BMO and presents an interesting case. We’ll start simple - the Charts Tab (just the Vol; with IV30ô (red line) vs HV10ô (white line)).

What we’re looking at:

(1) The first earnings cycle highlighted (Jul ’09) we see the white line (HV10ô) spiking past the red line (IV30ô). In this case, the ATM straddle the day before earnings was a purchase - i.e. it was worth more the next day. Details to come...

(2) The second earnings cycle (Oct ’09) showed the opposite. The the white line (HV10ô) stayed below the red line (IV30ô) - though note that the red line did dip (as expected) and the white line did rise (as expected).

(3) The third earnings cycle (Jan ’10) was just like the cycle in Jul ’09 - but even more pronounced. Vol was a super purchase as the stock gapped up on earnings more than the implied vol "forecasted."

Now to the details - the Earnings & Dividends Tab snapshot is included (click to enlarge).

What we’re looking at:

(1) The top ROW is FDO stock price 5 trading days before earnings through 5 trading days after.
(2) The second ROW are the front 2 month ATM straddles for the same period - focus on purple - the front month.
(3) The third ROW is the implied vol for those straddles - focus on the red - the front month. NOTE: The red line always collapses after earnings - this is called the vol crush after earnings.

What do we see?
For the far left earnings cycle (Jul ’09) we see specifically vol went from 59 --> 39 after earnings. 20 vol point drop! So clearly vol was a sale right?... Sell high / buy low?... No?... In fact it wasn’t a sale...

The straddle went from $2.15 ---> $3.63; a whopping 68% one day move on the stock gap. A perfect example of how dipping implied vol does not guarantee a good a sale. The implied vol dropped b/c the event (news) was over.

Following similar analysis we can see Oct ’09 earnings were a sale: Straddle went from $2.35 ---> $1.32 for a 43% one day drop.

The most recent cycle was a purchase: $1.78 --> $3.42 for a 92% one day gain.

So - what’s the point?... There are pro-traders on this floor that only trade earnings. They find companies which have significant odds of being either a sale or a purchase - they play that one day game, and make millions a year. As you see, you’re looking at 40% - 90% one day changes in FDO. Of course, if you do it badly, you’re out of cash and broke really fast.

What do they look for?
Companies with huge pre-dispositions to be sales or purchases... i.e. 10/10 or 9/10 times where one side was a winner. For the record, FDO isn’t one of them...

This is trade analysis, not a recommendation.
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