Analysis of an IBM Earnings Trade

Students from CBOE classes often keep in close touch with us long after they have visited the Options Institute.  I heard from one OI alumnus on Monday who noticed that IBM was set to report earnings after the close. They also had taken a look at the stock price reaction to earnings over the last three years.  On average IBM has moved up or down about 4%, but the majority of those moves had been to the downside.  The thing that stood out for this former student was that the biggest move to the upside out of IBM was only 1.77%.  Based on that information, with IBM just under 160.00, they decided to do the following trade –

Sell IBM Jul 22nd 165 Call at 1.69

Buy IBM Jul 22nd 180 Call at 0.09

Net Credit = 1.60

The payoff diagram below assumes they will hold the trade through Friday’s expiration (they didn’t).  At first glance the dollar risk / reward isn’t all that attractive with a 1.60 gain vs. a potential 13.40 loss.  However, IBM would need to rally 12.5% after earnings which would be well outside the historical norm.

IBM PO 2

I’m able to write this trade up for two reasons.  First the trader behind it agreed to let me tell their trading story.  Second, they exited the short leg of the spread today though buying back the 165 Call at 0.06.  IBM is still hovering around the 160.00 range and the 165 Call experienced what trader’s commonly refer to as a volatility crush.

From the trader I got a the comment that they didn’t think the last $6 of profit was worth checking the stock two or three times a day.  It’s hard to argue with that.