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Can We Profit From Volatility Expansion Into Earnings?


In one of my previous articles I described a study done by tastytrade, claiming that buying premium before earnings does not work. The title of the study was "We Put The Nail In The Coffin On "Buying Premium Prior To Earnings".

I demonstrated that their study was highly flawed, for several reasons (strikes selection, stocks selection, timing etc.)

It seems that they did now another study, claiming to get similar results.

The study was done today - here is the link. The parameters of the study:

  1. Use AAPL and GMCR as underlying.
  2. Buy a ATM straddle option 20 days before earnings.
  3. Sell it just before the announcement.

The results of the study, based on 48 cycles (2009-2014)

  • AAPL P/L: -$2933
  • GMCR P/L: -$2070

Based on those results, they declared (once again) that buying a straddle before earnings is a losing strategy.

 

What's wrong with this study?

  1. Dismissing the whole strategy based on two stocks is completely wrong. You could say that this strategy does not work for those two stocks. This would be a correct statement. Indeed, we do not use those two stocks for our straddles strategy.
  2. From our experience, entering 20 days before earnings is usually not the best time. On average, the ideal time to enter is around 5-10 days before earnings. This when the stocks experience the largest IV spike. But it is also different from stock to stock.
  3. The study does not account for gamma scalping. Which means that if the stock moves, you can adjust the strikes of the straddle or buy/sell stock against it. Many times the stock would move back and forward from the strike, allowing you to adjust several times. In addition, the study is probably based on end of day prices, and from our experience, the end of day price on the last day is usually near the day lows, and you have a chance to sell at higher prices earlier.
  4. The study completely ignores the straddle prices. We always look at prices before entering and compare them to previous cycles.

Entering the right stocks at the right time at the right prices is what gives this strategy an edge. Not selecting random stocks, random timing and ignoring the prices.

 

half truth.jpg

 

As a side note, presenting the results as dollar P/L on one contract trade is meaningless. GMCR is trading around $150 today, and pre-earnings straddle cost is around $1,500. In 2009, the stock was around $30, and pre-earnings straddle cost was around $500. Would you agree that 10% gain (or loss) on $1,500 trade is different than 10% gain (or loss) on $500 trade? The only thing that matters is percentage P/L, not dollar P/L.

 

Presenting dollar P/L could potentially severely skew the study. For example, what if most of the winners were when the stock was at $30-50 but most of the losers when the stock was around $100-150?

 

Tom Sosnoff and Tony Battista conclude the "study" by saying that "if anybody tells you that you should be buying volatility into earnings, they really haven't done their homework. It really doesn't work".

 

At SteadyOptions, buying pre-earnings straddles is one of our key strategies. Check out our performance page for full results. As you can see from our results, the strategy works very well for us. We don't do studies, we do live trading, and our results are based on hundreds real trades.

 

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.

 

So we will let tastytrade to do their "studies", and we will continue trading the strategy and make money from it. After all, as one of our members said, someone has to be on the other side of our trades. Actually, I would like to thank tastytrade for continuing providing us fresh supply of sellers for our strategy!

 

If you want to learn more how to use it (and many other profitable strategies):

 

Start Your Free Trial

 

Related Articles:

How We Trade Straddle Option Strategy
Long Straddle: A Guaranteed Win?
Why We Sell Our Straddles Before Earnings
Long Straddle: A Guaranteed Win?
How We Made 23% On QIHU Straddle In 4 Hours

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I wish you would have mentioned I'd have to listen to 6 minutes of BS about mice and rats (lol).  With tastytrade education you get what you pay for.  In addition to the points you mention, these straddles can trade in a wide range the last day and by my observations are usually near their low at close where I assume they take the mark for their study.  

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I didn't want to be the only one who suffered those 6 minutes..

 

Good point about last day pricing. To be fair, they couldn't really test it because they have the EOD prices only. 

 

Regarding the price of education - yes, there’s always free cheese in a mousetrap, but I never saw a happy a mouse there!

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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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Guest Minty415

Posted · Report

10-11am CT daily they have a segment where u can call them live on air to discuss anything u want. Would love to listen in

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You mean you sold them before earnings and held through earnings? Of course it can work - in fact, it will probably work for most stocks because on average, options are overpriced before earnings (but your return on margin will usually be very small and not worth the risk).

 

But this is not what the study was about.

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