Dell posted earnings that seemed pretty good and yet the stock dropped. Right after the earnings report the general opinion was as follows.

Dell said the strong results in the quarter reflected strength in enterprise products and services, improved average selling prices and favorable component costs.

The company did not provide specific guidance, but did say near-term results could be hurt by a slower decline in component costs in the second half.

Sounds good, right? After hours trading was up, before hours trading was up. Then when the market opened DELL dropped, and kept on dropping. Many at the by Yahoo or Google bulletin boards were asking the following.

with all the great Q2 news and we were down ans the NAS was up 31.06, HP hits new highs

and an answer comes as follows:

Dell is down because it is both a POS stock and a POS company. It is that simple.
Maybe when they quit losing market share people will care about this loser company again. But right now, it is an embarrassment to the industry.

So the guy who answered is a genius? Wrong. In any situation you will have people asking, “what went wrong.” And you will have people say, “here is why.” What you need to realize is that it is not always the same people saying what went wrong and why.

Though one website did seem critical of the earnings (DELL Nothing To Write Home About). I looked at those analysis and thought no, can’t be that since certain parts of their business is quite strong. I also know from public speaking that there are oodles of DELL notebooks.

Could it be then their prediction that the slowing drop of component costs will decrease profitability is not applicable to DELL, but also HP. So I decided to look at HP and looked a bit closer at the past six months comparing HP with DELL. For the past six months there does seem to be some pair’s trading or statistical arbitrage going on.


One could argue that maybe DELL was getting ahead of itself and thus a drop was needed.   

Looking at DELL by itself for the past five days you have the following graph.


On Monday and Tuesday it was run of the mill buy and selling of stocks. Then on Wednesday, and Thursday things went nuts. Thursday was earnings report day. On Friday then all of the sudden the stock dropped. You saw good earnings, a good market and the stock dropped like a rock even though the market rallied. 

You could argue that the stock climbed too much and thus people were buying on the rumor, and selling on the news. With the pairs trading, and this suggestion a stronger case could be made that DELL was overbought. I don’t completely buy this, and actually think the market decided to stop buying causing a drop, and then people started to buy.

I think the market decided to stop buying because of how my positions were affected. Going into earnings I had the following positions.

  • Tuesday closing bought Sept 27.5 call options for 0.85 priced at 35% implied volatility.
  • Wednesday closing bought Sept 27.5 put options for 0.080 priced at 34% implied volatility.
  • Thursday pre-hours trading bought stock at 27.72 thus closing my strategy.

For reference information the CBOE has pegged DELL with a historical volatility of around 41%. Most traders would agree that I was pretty well setup for whatever earnings would bring.

What happened Friday surprised me. In pre-hours Friday the stock “behaved” as it should have. But when the market opened I had a massive surprise as everything dropped, including stocks and options.

This is where I feel there is a unique case study in that the volatility dropped down to 25%. Thus any strategy would have failed unless you had shorted volatility. What is important is that implied volatility is the market price, and the market said that the volatility of DELL is 25%. I feel that the earnings resulted in people saying we are not going to buy. We might sell, but not panic sell.

I also felt this was a seize up of the market due to the low volume until the lowest point in the price was reached. At that point quite a few stocks started changing hands. And the buying an selling reached a frenzy at 15:52 EST. At that time my computer acted (fan) as if it was running one of my simulations. I looked and saw that DELL was being bought and sold like there was no tomorrow. Look at the following IB price histogram.


It’s hard to see, but look at that single red line that spikes at 2.2 million shares. That was 15:52, and on the Yahoo charts the huge bulk of shares were traded at the end of the day. The amount of trading at that point was abnormal.

This confirmed my suspicions that people were not buying, and thus causing a drop in volatility. And since people did exchange shares it does mean that DELL’s earnings were good. I just feel that there was strategic positioning going on.

In the end how did I trade this situation? Here was my game plan.

  • Early in the morning took advantage of the drop and bought Oct 2007 call options, and then sold them for a profit.
  • Before the big dip I calculated the probability of the depth of a drop, and bounce back.
  • Based on the probabilities I doubled down, and then set up selling points for the calls and stock, 28.15.
  • At the near bottom unloaded my puts, with a net loss due to volatility drop.

My new game plane was to unwind in whatever way possible, since a long weekend would have my options drop another dime (theta was 0.03). And who knows what the weekend will bring.

I stuck to my game plan even though I could have earned more money. But my game plan was to get out with a profit, not profit maximization.

Here is what makes this situation unique:

  • Earnings were good, and the stock dropped on low volume.
  • Because the market was rallying this could have been a horrible pair’s trade since you might have jumped in too early.
  • The stock did rise once people decided to buy.
  • The volatilities budged up 1 or 2% throughout the day. 
  • The bulletin boards had no clue as to what was right or wrong. After all if DELL was a bad buy, why the huge buying binge near the end of the trading session before a long weekend on the last day of August?

One last note, I actually wrote this blog entry as description of the situation as it is still fresh in my mind. I want to be able to go back to this blog entry a year later and understand what worked and did not work. This is why I am calling this a case study.

That leads me to the next question to you the reader. Did you find this interesting? Do you have any case studies? I don’t know if I will be creating another case study, but do you want to be emailed? Send me your thoughts at christianhgross at