Options Theory: Gaming Electronic Arts for Cash Flow
February 22, 2019
Today we’re dispensing with theory. It’s time to get practical. I enjoyed laying out cash flow ideas on Coca-Cola, so I’m going back to the well with a case study on none other than Electronic Arts.
The objective is to show you how I identify the trade setup and use implied volatility to select an appropriate options strategy. Spoiler alert – I’m going to end up building a bull put spread.
The Chart
After losing half its value last year, EA stock finally found a bottom around Christmas. Maybe Santa was feeling generous. More likely the 50% haircut was finally sufficient to price-in the deterioration in the company’s earnings. Either way, the price took a bullish turn and now finds itself above rising 20-day and 50-day moving averages.
Volatility reared its ugly head this month bringing some excitement to the party. First, another earnings whiff delivered a large down gap. Then, just in the nick of time, EA released a sweet new Battle Royale game(that I may or may not have been spending hours and hours playing) called Apex Legends. The game has been a hit with over 25 million players logging in over the first few weeks.
Traders went on a buying binge sending EA to the moon. From $80 to $110 in about a week. That’s a ridiculous – and likely unjustified – jump in such a short period of time.
Unsurprisingly, cooler heads have prevailed and we now have a tantalizing bull retracement pattern on our hand.
A Volatility View
With the VIX now dwelling in the cellar it’s challenging to find juicy premiums worth selling. In other words, implied volatility ranks lie low in stocks across the board. BUT not with Electronic Arts!
The recent excitement has its premiums pumped. Its IV rank is downright perky at 51%. The only other stocks that have a higher rank on my watchlist are companies with looming earnings announcements.
So…
Bull Retracement Pattern + High IV Rank + No earnings = Sells puts muchacho!
The Strategy
Selling puts offers a high probability, positive theta way to capitalize on neutral or bullish behavior. The key question is whether we want to sell naked puts or bull puts.
Settling the question is simple. If the stock price is high then sell bull puts. If it’s low, naked puts are the way to go. At close to $100, EA is better for bull puts.
If we’re using April expiration, there are two spreads that are viable. We could go more aggressive and sell the $85/$80 bull put for around 90 cents. OR, move further OTM and sell the $80/$75 bull put for around 50 cents.
Of course, we can’t forget the importance of a trigger. After all, EA could succumb to gravity. Maybe buyers don’t show up and defend their newfound uptrend. Waiting to deploy the spread until the stock breaks a prior day’s high or at least intraday resistance is smart.
Final point. Given the stock’s big swings, I like the idea of scaling-in here. This is an entry technique I’ve explored before. It allows us to take advantage of any adverse moves that may materialize over the duration of the trade.
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