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.

Selling Strangles Prior to Earnings


Question from a reader: What is your opinion on a short strangle vs a short straddle? I understand the same unlimited risk will be there because you are trading naked options. I found that one strategy I have had some success with in paper trading is using short strangles around earnings to take advantage of large drops in volatility.

I was taught that one of the assumptions used in this strategy is that for the most part, the market has all ready priced the option correctly for the upcoming news so by allowing for some price movement within your strangle, this is more of a volatility play than a price play.

 

Mark's response:

 

1) To me they are the same, with the straddle being a subset of the strangle  In other words, a straddle is merely a strangle when the strikes and expiration dates are the same.

 

I prefer the strangle because it allows the trader to choose call and put strike prices independently, rather than being 'forced' to choose the same strike.  I prefer to sell OTM calls and puts – and that's not possible with a straddle.

 

As far as unlimited risk is concerned, that's a decision for each trader.  I prefer the smaller reward and increased safety of selling credit spreads (an iron condor position), but that is not relevant to today's post.

 

2) A clarification.  In is not 'volatility' that incurs a large decrease after the news is released.  Instead it is the implied volatility of the options.  I'm fairly certain that is what you meant to say.

 

3) Your earnings plays are far riskier than you currently believe them to be. These are not horrible trades, but neither are they as simple as you make them out to be.

 

4) I must disagree with whomever it was who told you that "the market has priced the option correctly for the upcoming news."  The market has made an estimate of how much the stock price is likely to move.  Note that this move may be either higher or lower ad that this difference is ignored when the size of the move is estimated.

 

There is no formal prediction of move size.  There is nothing that says the stock will move 6.35 points.  What happens is the implied volatility rises as longs as more and more buyers send orders to purchase options.  And it makes no difference if they are calls or puts.  At some point option prices stabilize (or the market closes for the day) and a 'final' implied volatility can be measured. 

 

From the IV, the 'anticipated move' for the underlying is determined.  AsI said, it's not as is everyone agreed on how much the stock will move.

 

I hope you understand that when the news is released, there is very little chance that the predicted move is the correct move.  Many times the move is far less than expected.  That's the reason why selling options prior to earnings can be very profitable.  The IV collapses because another substantial price change is NOT expected and there is no reason to pay a high IV to buy either calls or puts.

 

However, if you chose to sell an option that was not very far out of the money (OTM), and if the stock moves far enough, then the IV decrease doesn't do a whole lot of good.  Sure you gain as IV plunges, but you can easily incur a substantial loss when the short option has moved significantly into the money.

 

Also remember that part of the time that stock price gaps by far more than expected.  In that scenario, a higher quantity of formerly OTM options are now ITM.  Thus, large losses are not only possible, but they are more frequent that you realize.  Apparently your trades have worked out well (so far).

 

Think about this:  If those option buyers did not profit often enough to encourage them to pay 'high' prices for the options they buy, they would have stopped buying them long ago.  The truth is that these option buyers collect often enough to keep them coming back for more. 

 

5) That means you must be selective in which options you sell into earnings news.  This is especially true when you elect to sell naked options.  You cannot options on every stock, hoping that any random play will work.  This is a high risk/high reward game.  It's okay to participate, but please be aware of what you are doing and the risk involved.

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

  • Options on Options

    Traders have long known that options can be opened on many different securities. Among the most ingenious of these are options on options. There are four types of these: call on a call (CoC), a call on a put (CoP), a put on a call (PoC), and a put on a put (PoP).

    By Michael C. Thomsett,

    • 0 comments
    • 150 views
  • The Wheel Trade

    The “wheel” trade is variously described as a beginner’s strategy, a combination to exploit features of both calls and puts, and as “perfect” solution to the well-known risks of shorting calls, even when covered. The wheel could be defined as any of these, but a larger question should be: Is the wheel an elegant method for making profits consistently, or just a gimmick?

    By Michael C. Thomsett,

    • 0 comments
    • 458 views
  • Chooser Options

    Most options traders see their world as a choice between calls or puts, alone or in various combinations. But there is more. With a chooser option, traders can open a position and decide later whether it will be a call or a put. This is also called an as you like it option.

    By Michael C. Thomsett,

    • 0 comments
    • 397 views
  • Leveraged Anchor 2020 Year In Review

    Steady Options has now been trading the Leveraged Anchor strategy for two years, and, somewhat to my surprise, 2020 went even better than 2019. On the year, Leveraged Anchor was up 31.7%, while the total return of the S&P 500 was 18.4%.

    By cwelsh,

    • 2 comments
    • 1,168 views
  • Ratchet Options

    The “ratchet option” is so-called because as a series, each successive position activates when the previous option has expired. The trader ratchets up (or down) to the next position. Each one is set up to be as close to the money as possible. It has many names, including cliquet, moving strike, ladder, lock-in, or reset option.

    By Michael C. Thomsett,

    • 0 comments
    • 419 views
  • Steady Momentum 2020 Year in Review

    Steady Momentum Put Write (SMPW) is one of the available subscription services at Steady Options. We launched the strategy in early 2019, so we now have two years of performance to evaluate on both an absolute basis and relative to the strategy’s benchmark, PUTW (WisdomTree CBOE S&P 500 PutWrite Strategy Fund). 

    By Jesse,

    • 0 comments
    • 401 views
  • SteadyOptions 2020 Year In Review

    2020 marks our 9th year as a public trading service. It was an excellent year for us. We closed 130 winners out of 194 trades. Our model portfolio produced 117.1% compounded gain on the whole account based on 10% allocation per trade. We had only three losing months in 2020. 

    By Kim,

    • 0 comments
    • 683 views
  • The Jump-Diffusion Pricing Formula

    One of the more complex areas of options analysis involves pricing formulas. The best known among these is the Black Scholes Model (BSM). This is a widely cited method for attempting to determine what the option’s premium should be, but it is deeply flawed.

    By Michael C. Thomsett,

    • 0 comments
    • 444 views
  • Ranges of Exotic Options

    The standard call and put are well known to all option traders, but many exotic and more advanced options can also be opened. Whether a specific broker allows trading in these, and whether a trader has the necessary trading level, are questions to be addressed. This article just defines many of the exotic options that are possible.

    By Michael C. Thomsett,

    • 0 comments
    • 528 views
  • What To Do Before Committing To Trading

    Trading cryptocurrency has become a very popular and significant part of life. While it’s not for everyone, it’s certainly for an awful lot of people. There’s money to be made and areas to be invested in, and people will do what they can to make either a quick buck or an amazing figure.

    By Kim,

    • 0 comments
    • 689 views

  Report Article

We want to hear from you!


 

Mark, You are back! Just today I picked up your Rookies books and re-read the chapters on diagonals (for about the 20th time). When you wrote the second edition you added a chapter for calendars and also some additional material on diagonals. With regard to volatility (IV) and also VIX would you say that a trade consideration should be low put volatility for entry and bank on the high theta for the short side?

 

Share this comment


Link to comment
Share on other sites


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