Depending on how you manage your positions, volatility can be your friend, or it can be a foe. While comparisons of historical and implied volatility can help you determine a stock's current risk of price variation, aside from knowing when the company's earnings date is, there aren't too many ways of predicting spikes in implied volatility. One statistic that can help in identifying these spikes before they happen is the short interest currently outstanding in the market. While this alone does not necessarily imply future volatility, when earnings announcements are around the corner, the probability of increased short-term volatility will be greatly increased as short sellers could be squeezed on good news or holders of the stock dump their positions to get out on bad news. Below I've listed the criteria that needs to be met before I even consider looking at a stock for a swing trade.
Price > 10/share
Average Daily Volume > 500,000 shares
Short Interest Ratio > 15
% of Float Held Short > 25%
Earnings Call within 2 weeks
The short interest ratio being greater 15 represents that the number of "days" worth of trading volume is currently held short. A high short interest ratio can correlate strongly to steep moves in an asset price during a short squeeze. Because up to15 times the normal trading volume of shares could flood the market on the buy side, rapid movement higher along the ask price can occur causing shares to rip higher throughout the trading day. The percent of float held short can be used in a similar fashion as well as to measure the conviction of the short sellers. It isn't uncommon for some stocks to perpetually have 3% or 4% of their shares held short at any given time, but when a firm has 30% or 40% of their shares held short, it then would seem that there is greater conviction in the short sellers' intentions.
As mentioned earlier another key necessity is for the company to be announcing earnings (or have some other significant announcement upcoming). Such events will act as catalysts to trigger any potential spike in short-term volatility.
Boston Beer (SAM) - The makers of Samuel Adams and Twisted tea currently trade at almost 7 times book value and a Price-to-Earnings Growth Rate of 2.25. A recent look into insider trading shows that the Chairman of the Board (James Koch) has sold off 18% of his personal holdings in the company over the past month. His selling of stock coincides rather nicely with the stock's recent break over the $100/share mark. It is important also that I note that unlike what is customary for officers to do (exercise options, then sell the stock same day), Mr. Koch's selling was not done as a result of options being exercised. Starting on March 19, and going through April 13, the Chairman sold off 49,500 shares. SAM reports earnings on May 4, has a short interest ratio of 24.27 and 33.47% of its float held short.
LONG June 90 Put Options (bid/ask spread of .85/1.25)
LONG June 110 Call Options (bid/ask spread of .60/1.00)
This trade will be profitable as long as volatility increases and the stock moves significantly in either direction.
Skullcandy Inc. (SKUL) - Skullcandy, maker of headphones and other audio equipment is set to report earnings for Q1 of 2012 on May 7. Analysts expect the company to earn 4 cents per share this coming quarter and with great unknown has come great pressure on the stock by short sellers. 34.82% of the stock's float is currently held short, which is equivalent to about 16.10 days worth of trading volume.
LONG June 15 Put Options @ $0.90
LONG June 17.50 Call Options @ $0.65
The implied volatility has already increased significantly, however I have to believe that with many questions coming into this quarter (it being the first post-holiday quarter the company will have had to report publicly) there will be a significant post-earnings move. I certainly believe that this earnings call will very clearly define the future of this company.
DreamWorks Animation SKG Inc. (DWA) - The creator of the loved animated movies "Shrek" and "Madagascar" has an earnings call planned for the week of May 2, at which point investors hope the company meets the analyst expectations of 9 cents per share for the quarter. Not all investors feel positive about this company's story however, as 28.78% of the float is held short, which represents 22.82 times the daily average volume of the stock. Technical traders would say that there is some significant support that the stock would have to break in order to continue any further move down. That support rests around the $17/share price level and shares currently rest right near there at $17.87/share.
LONG May 17.50 Put Options @ $0.55
LONG September 20 Call Options @ $0.85
Current Implied Volatility for this stock is significantly lower than the historical volatility (37.7% and 43.4% respectively) allowing traders to take a position using relatively speaking cheap options. While there is a significant short interest in the stock it is also prudent to note that open interest on the September 20 Strike Calls stands above 7,000 contracts. These could be being used as hedges for the shorts against an upside swing or it could be the bullish supporters of the stock making their stand.
Charts Obtained through FinViz.com.
Short Interest obtained through SchaeffersResearch.
Earnings Dates obtained through TD Ameritrade.
Insider Trading Information obtained through SEC Edgar System.
Disclosure: I am short SAM.
Additional disclosure: I am LONG Put options on SAM and may consider trades in DWA and SKUL during the next week.