Earnings Straddles: the Ultimate Protection
Our followers already know that buying pre-earnings straddlesis one of our key strategies. I described it here. The idea is to buy a straddle (or a strangle) few days before earnings and sell just before the event. IV (Implied Volatility) usually increases sharply a few days before earnings, and the increase should compensate for the negative theta. If the stock moves before earnings, the position can be sold for a profit or rolled to new strikes.
While we use this strategy on a regular basis, it is not among our most profitable strategies. During periods of low volatility, it usually produces 3-5% return per trade (including the losers). To put things in perspective, even 3% return is not that bad. The average holding period of those trades is around 5 days, so 3% return translates to 219% annual return. If you traded 40 straddles per year and allocated 10% per trade, those trades alone would contribute 12% to your account. Considering the low risk (the straddles rarely lose more than 7-10%), this is a pretty good return.
But this is where it really gets interesting: I consider those trades a cheap black swan protection. If IV goes up sharply followed by the stock movement, this is where the strategy really shines. It can provide a really good protection to your options portfolio in case of sharp moves.
Examples
Lets take a look on few real life examples of trades that benefited from market volatility.
- Entered HPQ strangle on August 3, 2011, exited on August 8, 2011 for 109.7% gain.
- Entered DIS strangle on August 3, 2011, exited on August 8, 2011 for 107.1% gain.
- Entered CRM strangle on August 3, 2011, exited on August 8, 2011 for 101.7% gain.
- Entered AKAM straddle on July 23, 2012, exited on July 26, 2012 for 38.9% gain.
- Entered FNSR straddle on March 6, 2013, exited on March 7, 2013 for 24.2% gain.
- Entered MSFT straddle on June 24, 2014, exited on July 17, 2012 for 35.4% gain.
- Entered QIHU straddle on August 19, 2015, exited on August 19, 2015 for 22.9% gain.
To be clear, the returns from 2011 can probably happen once in a few years when the markets really crash. But if you happen to hold few straddles or strangles during those periods, you will be very happy you did.
Summary
To be successful with this strategy, you need to know what you are doing. Not every stock works equally well. There are many moving parts to this strategy:
- When to enter?
- Which stocks to use?
- How to manage the position?
- When to take profits?
If used properly, the pre-earnings straddles can provide decent gains during periods of low to medium volatility. But at the same time, they can provide excellent black swan protection. Are you familiar with another way to get black swan protection that costs you nothing - in fact, it even produces some gains? I'm not.
Related Articles:
How We Trade Straddle Option Strategy
Buying Premium Prior to Earnings
Can We Profit From Volatility Expansion into Earnings
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