SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Long Straddle Through Earnings Backtest


At SteadyOptions, we like to buy a straddle few days before earnings to take advantage of the Implied Volatility increase into earnings. We always sell those straddle before the earnings announcement. In one of my previous articles I showed Why We Sell Our Straddles Before Earnings.

The reason is simple: over time the options tend to overprice the potential move. Those options experience huge volatility drop the day after the earnings are announced. In many cases, this drop erases most of the gains, even if the stock had a substantial move. In order to profit from the trade when you hold through earnings, you need the stock not only to move, but to move more than the options "predicted". If they don't, the IV collapse will cause significant losses.

earnings.jpg

Kirk Du Plessis from OptionAlpha seems to agree. 

He conducted a backtest proving that holding a straddle through earnings is on average a losing proposition.


Here are the highlights of his research.
 

Key Points:

  • Often times traders go through cycles where the stock makes incredibly big moves.
  • This encourages traders to buy long straddles heading into earnings; a long call/put at the money assuming that the stock will make a big move so that you can profit from it. 
  • However, it is not the case that the stock always consistently moves more than expected in the long term. The market is smart enough to overcorrect and implied volatility always overshoots the expected move, on average. 

Case Study 1: Apple

Did a long straddle every time earnings were present, all the way back to 2007 through now. This is a lot of earnings cycles and a lot of different information for Apple. Since then Apple has had a considerable move, which really challenges the validity of the strategies. We entered a long straddle at the money the day before earnings and took it off the next day. The stock was trading at $90; we bought the 90 put and the 90 call and closed it right after earnings were announced the next morning. 

Results: 

  • A long straddle in Apple for earnings only ended up winning 41.38% of the time. 
  • The average return over 10 years was -1.31%.
  • Over the long haul, a long option strategy results in a negative expected return, especially in a stock like Apple.
  • On the opposite end of this trade, if you had done the short straddle instead of buying options, you would have generated at least 60% of the time and expected a positive return. 
  • The straddle price before earnings, on average, was $15. 
  • The straddle price directly after earnings went down to about $7.95; not a great choice for long-option buyers.

Case Study 2: Facebook 

Entered the same long straddle position, entering right before earnings were announced and exiting again right after earnings were announced. This strategy only won 27% of the time, which is a huge miss for Facebook percentage-wise. These long options strategy simply do not perform as well as we think over time.

Results:

  • Had an annual return of 0.70%.
  • Only a couple of months ended up being the determining factor to keep it above board. 
  • If you missed a couple of those really big moves or if Facebook moved much higher than expected, then it would have resulted in a much more negative return.
  • On the counter side, if you had traded the short option strategy it would have worked out well, generating a positive expected return. 
  • On average, the market priced these straddles at about $5.62 before earnings.
  • After they announced earnings, the straddle pricing went down to $1.78. 
  • The key was that the crash in the volatility and the straddle pricing is really why this strategy was a big loser. 
  • However, this was a really good winner for option sellers.  
  • The average expected move in Facebook was $6.45 and the actual expected move on Facebook was $7.09.
  • Facebook out-performed on average. 
  • If you could remove the biggest outlier from 2013, then Facebook under-performs by $6.16.
  • More recently, Facebook has begun to consistently under-perform its expected moves.

Case Study 3: Chipotle

With Chipotle we used the same strategy as with Apple and Facebook, entering into a long straddle right before earnings and exiting it right after earnings. 

Results:

  • The overall win rate was 35.48%.
  • The average annual return was -2.59%, losing a significant amount of money in the trade. 
  • This again consistently led option sellers to be the beneficiaries of the earnings trade in Chipotle.
  • The average price of the straddle heading into the earnings event was 26.26%.
  • The stock went from the low 60's, all the way up to the 600's and back down to 400 - so the straddles are naturally going to be more pricey. 
  • On average the straddle price was 26.26 and after earnings the straddle price was 11.21, collapsing by more than half. 
  • There are huge moves in Chipotle, but they do not overshadow what actually happened in the long term.
  • Expected move in Chipotle was 7.01 and the actual move was 5.28 - the market vastly underperformed. 

Conclusion:

  • After big moves, we start to see expected moves and the stock expands and then smaller moves follow.
  • Generally speaking, when the stock outperforms the expectation the next couple of cycles end up being fairly quiet. 
  • If we do find ourselves in a quiet period where the stock has performed really well, we should be careful that it could surprise us shortly. 
  • Likewise, if the stock has been really volatile and has outperformed and moved more than expected in the last couple of cycles that means we could potentially be more aggressive as it might underperform heading forward.
  • Generally, there is also a lag time between the market catching up - earnings trades only happen four times a year. 
  • The market participants don't get a lot of data throughout the year to make changes to expectations and trading habits. 
  • If the stock has a huge move after earnings, more than expected, it might take a cycle or two for the options pricing to catch up and realize the new normal. 
  • At the end of the day, realizing how much these numbers gravitate towards what they should be on average, long-term is really powerful. 

You can listen to the full podcast here.

This research confirms what we already knew:

It is easy to get excited after a few trades like NFLX, GMCR or AMZN that moved a lot in some cycles. However, chances are this is not going to happen every cycle. There is no reliable way to predict those events. The big question is the long term expectancy of the strategy. It is very important to understand that for the strategy to make money it is not enough for the stock to move. It has to move more than the markets expect. In some cases, even a 15-20% move might not be enough to generate a profit.

Thank you Kirk!

The next question is of course: if holding a long straddle through earnings is a losing proposition, why not to take the other side and short those straddles?

But lets leave something for the next article..

Related articles:

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • How To Create Your Own Indexed Annuity

    Indexed annuities are a life insurance company product sold by insurance brokers for a commission that is based on the amount deposited into the contract. Contract performance is linked to popular indexes like S&P 500, and early withdrawal penalties typically apply for the first 7-10 years if withdrawals greater than 10% of the contract value are taken each year.

    By Jesse,

    • 0 comments
    • 877 views
  • Q&A with Mental Game Coach Jared Tendler

    QUESTION: Thank you for taking the time to participate in a Q & A session with Steady Option. Let’s start with an introduction and a little bit of background on who you are and how you got here.

    By Jared Tendler,

    • 0 comments
    • 1,101 views
  • Using TLT Options to Increase Expected Returns of a Buy & Hold Portfolio

    TLT is the iShares 20+ Year Treasury Bond ETF that seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. Even though US Treasuries typically act as a diversifying asset class to mainstream equities, many investors with long time horizons may not be interested in holding TLT in their portfolio because it would lower expected returns.

    By Jesse,

    • 0 comments
    • 1,313 views
  • Tax Efficient Trading Part II: Capital Gains Deferral

    In part I I illustrated how the preferential tax treatment of 1256 contracts could improve after tax returns of a PutWrite strategy over a long period of time. In this article, I’ll continue the illustration by switching from a PutWrite to an ETF BuyWrite (covered calls) strategy while holding pre-tax expected returns constant at 8%.

    By Jesse,

    • 0 comments
    • 1,617 views
  • Tax Efficient Trading Part I: The 1256 Contracts

    Cash settled index options like SPX, XSP, RUT and a few others receive special federal tax treatment where 60% of the gains are reported as a Long Term Capital Gain (LTCG) even if the contract was held for less than a year.

    By Jesse,

    • 0 comments
    • 1,599 views
  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 1 comment
    • 2,406 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 1,732 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 2,813 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 1,338 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 2,958 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido