Watching Options to Gain a Trading Bias

05/04/2010 12:01 am EST


There was a time when Garmin (GRMN) was quite the high-flying stock, quickly running up into the triple digits. Its innovative GPS tracking system could get a driver from point A to point B with ease, and it was thought that everyone in the world would want a Garmin in their cars in a matter of years.

That turned out to be half true. Almost everyone does have a GPS tracking device in their car, but as TiVo (TIVO) felt with the generic DVR, and Sony (SNE) felt with the generic Walkman, many people view these devices as a commodity and are not tied to a specific brand. (Personally, I never bought one because I don't like the tone of the woman's voice when she arrogantly tells me she is "recalculating.")

The stock has since come back down to earth to a more reasonable $37.38 as of Friday's close.

I thought it might be fun to play this stock into its earnings announcement, which is scheduled for Wednesday before the open.

Garmin Earnings Trade

Historically, GRMN has been hit or miss on earnings. The stock has typically moved between 5% and 10% on earnings announcements during the last two years. It has slipped in a couple of 20% moves (although those happened when the stock was less expensive).

On the implied volatility (IV) front, the at-the-money (ATM) straddle is currently priced at about $4, a 33% premium over non-earnings months. The May implied volatility is 54%, almost 20% higher than at this time in April. And June is priced at 46% implied volatility—only a slight uptick in IV relative to "normal" times.

The stock has been rallying (as all have) over the last few months, but has stalled out.

Basically, I do not have a directional bias.

Bringing all of this information together, I am thinking that a term trade makes the most sense. There appears to be about $1 of earnings premium in the straddle. The front-month options are elevated, and the back months do not appear to be.

If I had a directional bias, a diagonal spread would be a really good play, but since I do not, I am going to try a calendar spread (a long and short position on the same underlying asset, but with different expirations) or a double calendar (two calendar spreads using the same expiration months, but different strikes).

I can buy the GRMN May-June 37 calendar spread for about 60 cents. My first impression is that this is a cheap calendar and might not be a bad trade. However, it does not appear to give me the more than 10% cushion I am looking for on each side of the straddle. While this is one I would consider (especially if it got below 50 cents), I am really trying to stick to my guns here and get at least 10% cushion on both sides.

My next attempt is a double calendar set out at about $5 around the current price. I can construct a 35/40 double calendar that will cost $1.10. The trade does not have the same reward as the single calendar—in the middle it can only return about 75 cents on the dollar. In return, though, the trade has extra room on both the down and up side. This meets my criteria, but is it worth the extra cost relative to the reward gained at expiration?

I decided to put together a simple risk matrix comparing one-day returns of the GRMN calendar and double calendar. The scenario I have set up compares the calendar to the double calendar if the stock doesn't move, is down 10%, and is up 10%. To try to mimic earnings, I also dropped the implied volatilities by 10% in May and 2.5% in June. This better simulates how the IVs will move on the earnings report.

Here is the risk matrix:

Click to Enlarge

The risk matrix makes it appear that the double calendar is the better selection. I am giving up a small amount of one-day return if things go as planned. If the stock moves 10% or more, the double calendar outperforms the calendar.

This is a very simple analysis. If I wanted to dig deeper, I would put together many scenarios moving IVs with varying severity and in several directions. I would also do the same with the price, moving it up and down 5%, 15%, and 20%.

This is only one way to try to play this stock. In a perfect world, there would be a woman on the Garmin telling me which way to trade the stock. Sadly, though, no such invention exists. So, I guess for now I will be stuck in my office "recalculating."

By Mark Sebastian of

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