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Google killed the options sellers.. again


Last year I wrote an article for Seeking Alpha Google Options Underestimated The Risk Again. Looks like history repeats itself. On Thursday Google reported blowout quarter and the stock rallied the next day a whopping 122 points (13.8%). The options markets implied a 33 points move.

Those who purchased the straddle a day before earnings more than tripled their money. However, for each buyer there is a seller. Those who sold those options (thinking that they are overpriced) got absolutely killed. They have lost almost $9,000 per contract. Well, of course not all of them - some of them sold those options as part of a hedge or maybe more complex trade, but you get the point.

 

So what are the lessons here?

 

First, NEVER ever sell naked options. Especially not before earnings. Especially not on stocks like GOOG, NFLX etc. that have a history of big moves. If you insist to sell premium, hedge yourself with further OTM options (creating an Iron Condor). Those who did it with Google, still lost 100% of the margin, but at least they knew their maximum risk in advance.

 

Second, be aware that earnings are absolutely unpredictable. If you decide to play earnings, do it only with a small portion of your capital and pre-defined risk.

 

Overall, options tend to be overpriced before earnings, and selling them with defined risk should produce good results over time - but you should always limit your loss and position sizing knowing that from time to time, there will be surprises. However, not all options are overpriced. There are some exceptions, and Google is one of them. Statistically, as I showed in my article, buying Google straddle a day before earnings would produce pretty good results.

 

Options trading can be very lucrative, but you should always remember about the risks. And if you are playing earnings, the only risk management tool you have is position sizing.

 

By the way, Google was not the only stock this week where the options market was terribly wrong about the potential move. Chipotle Mexican Grill (CMG) straddle was pricing a $28 move - in reality, the stock moved $70. Sandisk (SNDK) also moved almost double than the implied move. If you still believe that the markets are efficient, you live in a fantasy land.

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Great article and good advice!

 

I agree that markets are inefficient.  However, I don't think this particular example disproves market efficiency.  The efficient-market hypothesis (in its weak form) only argues that market prices reflect all publicly available information.  Since the earnings results are not publicly known prior to the announcement, the prices cannot reflect that information until after the announcement.  So, even if the markets were weak-form efficient (which they aren't), you could still have an earnings surprise.

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