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Buying Premium Prior To Earnings - Does It Work?


I got the following email today from tastytrade:

"We Put The Nail In The Coffin On "Buying Premium Prior To Earnings"
"We look at whether or not you could make money on the implied volatility expansion leading up to an earnings announcement."

Since buying pre-earnings straddles is one of our key strategies, I went to watch the segment.
Here is how their methodology works:

In theory, if you knew exactly what price a stock would be immediately before earnings, you could purchase the corresponding straddle a number of days beforehand. To test this, we looked at the past 4 earnings cycles in 5 different stocks. We recorded the closing price of each stock immediately before the earnings announcement. We then went back 14 days and purchased the straddle using the strikes recorded on the close prior to earnings. We closed those positions immediately before earnings were to be reported.

Study Parameters:
  • TSLA, LNKD, NFLX, AAPL, GOOG
  • Past 4 earnings cycles
  • 14 days prior to earnings - purchased future ATM straddle
  • Sold positions on the close before earnings
The results:
Future ATM straddle produced average ROC of -19%.

As an example:
In the previous cycle, TSLA was trading around $219 2 weeks before earnings. The stock closed around $201 a day before earnings. According to tastytrade methodology, they would buy the 200 straddle 2 weeks before earnings. They claim that this is the best case scenario for buying pre-earnings straddles.

But wait a minute.. This is a straddle, not a calendar. For a calendar, the stock has to trade as close to the strike as possible to realize the maximum gain. For a straddle, it's exactly the opposite:

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When you buy a straddle, you want the stock to move away from your strike, not towards the strike. You LOSE the maximum amount of money if the stock moves to the strike.

In case of TSLA, if you wanted to trade pre-earnings straddle 2 weeks before earnings when the stock was at $219, you would purchase the 220 straddle, not 200 straddle.

It still does not guarantee that the straddle will be profitable. You need to select the best timing (usually 5-7 days, not 14 days) and select the stocks carefully (some stocks are better candidates than others). But using tastytrade methodology would GUARANTEE that the strategy will lose money 90% of the time.

As a side note, the five stocks they selected for the study are among the worst possible candidates for this strategy. It almost feels like they selected the worst possible parameters in terms of strike, timing and stocks, in order to reach the conclusion they wanted to reach.

At SteadyOptions, buying pre-earnings straddles is one of our key strategies. It works very well for us. Check out our performance page for full results. As you can see from our results, "Buying Premium Prior To Earnings" is still alive and kicking. Not exactly "Nail In The Coffin".

Of course the devil is in the details. There are many moving parts to this strategy:
  • When to enter?
  • Which stocks to use?
  • How to manage the position?
  • When to take profits?
And much more. But overall, this strategy has been working very well for us. If you want to learn more how to use it (and many other profitable strategies):

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16 Comments

I had a great respect for Sosnoff.. after seeing some of his "studies", he completely lost my respect.

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This study was severely flawed.  Every trade was hurt by negative gamma, the opposite of one of the strategy's benefits.  Sosnoff needs to stick with interviewing Karen the SuperTrader.

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Another reason to always review & question research methodology (in any field). Like you say, the devil is in the details and even small details can make huge differences.

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The study doesn't make sense, unless I am not understanding it correctly. If you buys a 200 strike straddle when the stock is at 220, then you are long deltas, by a lot. So of course they will have losses when the stock moves down to 200. Sounds like they are setting up a straddle to lose on deltas every time. Is that really what they did in the study? That would defeat the entire purpose, which is to analyze if the IV rise leading up to earnings can be traded profitably, and that must be analyzed using a strategy that is initially delta neutral. And they used only a small sample size of high priced stocks, which also tend to have low gamma, so they are better candidates for calendar spreads. 

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ha as you say by picking the strike that they know is atm on the day before earning the pick the straddle which they know will have NO gamma gains. So even if the stock moved 20% over the 2 weeks they hold the straddle (which would give you a massive profit on you straddle!) they are picking the one that will lose in that scenario. I'm not sure whether that's ignorance or whether they wanted to manipulate the outcome of they 'study' (not sure why you would - so I'm going with ignorance)

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SteadyOptions
Jul 23 2014 12:16 PM

jgoptions, watch the segment (link at the top of the article) and see for yourself.

 

Marco, not only it will have no gamma gains, but it will most certainly have gamma losses.

 

Honestly, I was shocked after watching it. As I mentioned in the article, it's like they selected the worst possible parameters in terms of strike, timing and stocks. Ignorance or manipulation? You decide. For me, it's hard to believe that Sosnoff doesn't know how to set up a straddle properly.

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Yes, I did watch the segment, and I am shocked as well, so much so that I questioned if I was understanding it correctly. It's hard for me to believe that they would set up such a flawed study, but it looks like that's the case here.

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SteadyOptions
Jul 23 2014 02:30 PM

I really have no good explanation. I actually contacted them with those questions but got no response. I would be curious if they respond to someone else contacting them.

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I have listened to Tasty Trade, and everyone else. I am a scientist and try to remain objective. So what does this study tell me. My conclusion is its not what you do, it's how you do it. This is the problem with options and stocks, everybody thinks there is one secrete way. The secrete is understanding the why something happened a certain way. So far I have enjoyed Kim, and SO as I think he and SO has a very good handle on the why things happen a certain way. Remember when everyone thought the world was flat and they could not have been more wrong. That's why we need a leader like Kim, that has been there done that. We can learn from him and continue to learn with him. I am here because iron condors work great until they don't. So I have more to learn.

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SteadyOptions
Jul 26 2014 10:06 PM

Thank you for your kind words.

 

I wrote an article a while ago on Seeking Alpha where I argued that there is more than one way to trade options. Here is the link - http://seekingalpha....options-trading

 

I never claimed and never will that my way is the only way. Whoever claims such a thing is a fool. Who am I to say that I'm the only one who is right? There are so many smart traders out there. What I do works for me, it works for many of our members, but it definitely doesn't work for everyone.

 

What I tried to show in this article is few flaws in the way tasty trade conducted the study.

 

btw, I contacted them but got no answer. I also commented on the YouTube segment and Facebook, but my comments have been removed. I guess they are not ready to deal with my arguments. It's their prerogative of course.  

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SteadyOptions
Jul 30 2014 09:52 AM

This is our track record after this "study" has been aired:

 

XOM straddle 1.6%

EXPE straddle 16.6%

WYNN straddle 4.1%

SBUX straddle 2.7%

QCOM straddle 11.8%

MSFT straddle 35.4%

 

Isn't it ironic? Will someone tell Sosnoff?

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Kim, someone has to be on the other side of our trades. :)

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SteadyOptions
Jul 30 2014 11:16 PM

Kim, someone has to be on the other side of our trades. :)

That's true.. and since tastytrade has "slightly" higher following than SteadyOptions, maybe this article was a good thing for us. No wonder we are having such a good streak.

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John @ Park Research, LLC.
Jul 31 2014 05:41 PM

They curve their studies and they block those who disagree (me) on twitter.  And they call names on air (me).  I talked to some of their research team, they don't have enough brain power or integrity (they can choose) to do the study right.

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They have a caller segment at 10am CST if you want to dispute the study live over the phone.
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SteadyOptions
Dec 05 2014 07:17 PM

Got a response from tastytrade:

 

"we'd like to request that you please remove any tastytrade images and/or materials from your site."

 

Not exactly what I expected. Instead of commenting on the article, all they care about was their images. 

 

There are two things that I hate the most: lies and hypocrisy.

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