With about an hour to go in front of tonight’s earnings release, erstwhile growth outfit Green Mountain Coffee Brewers (GMCR) Weeklys May contracts are percolating strongly. In fact, if you’ve heard the expression, “Sell 100 and Buy 200!” as it relates to first fading spikes in implied volatility up to a certain level, but being smart enough to fold or close when conditions spell real out of control trouble; Green Mountain’s shares are just that sort of candidate.
The bid which stands at 260% IV for its near-the-money May Weeklys has more than a handful of valid reasons for investors and their willingness to bid premiums to seemingly rich, but also well-roasted levels. In the past year and working from May 2011, the immediate post-earnings aftermath has resulted in close-to-close moves of: 18.59%, 16.41%, -39%, 23.85% and a Starbucks (SBUX) driven wildcard of -15.72% in early March which looked to infringe on its K-cup single coffee relationship with the retail giant.
As each of those dramatic moves compares to today’s pre-announcement 260% IV bid; traders are pricing in a similar reaction. Specifically and theoretically speaking, the implieds tell us traders collectively expect a 1SD or 68% chance of GMCR trading as much as 19% from its current levels near 49.15 into expiration two days out on Friday.
Figure 1: Green Mtn Coffee (GMCR) 1x Iron Butterfly 40/50/60 May Weeklys
A dollar cost examination of the 49 straddle priced for $7.75 results in break-evens of about 16%. Slightly less than the 19% figure used by reducing yearly volatility into a two period percentage amount, the difference can be approached as comparing a simple unhedged straddle versus the former pricing wherein continuous hedging and concept of delta neutral trading is applied.
In the end, all trends are said to come to an end. Personally, our view is traders shouldn’t be quick to expect GMCR’s historical earnings reaction tendencies to cool off and simmer just yet. But if shorting the trend and premium in this case is how you like to get your morning jolt; we’d suggest looking into a butterfly or the iron butterfly shown above. Both spreads maintain limited risk features versus a short straddle. And while that strategy has a bit more froth on top, it also has a good deal more real world risk proven to exist.
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
Visit Chris Tyler’s Forum
The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.