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.

Why We Sell Our Straddles Before Earnings


Our regular readers know that buying an options straddle a few days before earnings is one of our favorite strategies. 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. I'm asked many times why we sell those trades before earnings.

In this article, I will show why it might be not a good idea to keep those options straddles through earnings.

 

As a reminder, a straddle involves buying calls and puts on the same stock with same strikes and expiration. Buying calls and puts with the different strikes is called a strangle. Strangles usually provide better leverage in case the stock moves significantly.

 

Under normal conditions, a straddle/strangle trade requires a big and quick move in the underlying. If the move doesn’t happen, the negative theta will kill the trade. In case of the pre-earnings strangle, the negative theta is neutralized, at least partially, by increasing IV.

 

The problem is you are not the only one knowing that earnings are coming. Everyone knows that some stocks move a lot after earnings, and everyone bids those options. Following the laws of supply and demand, those options become very expensive before earnings. The IV (Implied Volatility) jumps to the roof. The next day the IV crashes to the normal levels and the options trade much cheaper.

earnings.jpg

 

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.

 

Here is a real trade that one of the options "gurus" recommended to his followers before TWTR earnings:

 

Buy 10 TWTR Nov15 34 Call
Buy 10 TWTR Nov15 28 Put

 

The rationale of the trade:

 

Last quarter, the stock had the following price movement after reporting earnings:
Jul 29, 2015 32.59 33.24 31.06 31.24 92,475,800 31.24
Jul 28, 2015 34.70 36.67 34.14 36.54 42,042,100 36.54
I am expecting a similar price move this quarter, if not more. With the new CEO for TWTR having the first earnings report, the conference call and comments will most likely move the stock more than the actual numbers. I will be suing a Strangle strategy. 9/10.

 

Fast forward to the next day after earnings:

 

b7fd9a3ef206c9b19baaa409ef2246a9.png

 

As you can see, the stock moved only 1.5%, the IV collapsed 20%+, and the trade was down 55%.

 

Of course there are always exceptions. Stocks like NFLX, AMZN, GOOG tend on average to move more than the options imply before earnings. But it doesn't happen every cycle. Last cycle for example NFLX options implied 13% move while the stock moved "only" 8%. A straddle held through earnings would lose 32%. A strangle would lose even more.

 

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.

 

Jeff Augen, a successful options trader and author of six books, agrees:

 

“There are many examples of extraordinary large earnings-related price spikes that are not reflected in pre-announcement prices. Unfortunately, there is no reliable method for predicting such an event. The opposite case is much more common – pre-earnings option prices tend to exaggerate the risk by anticipating the largest possible spike.”

 

Related Articles:

How We Trade Straddle Option Strategy

Buying Premium Prior to Earnings
Can We Profit From Volatility Expansion into Earnings
Long Straddle: A Guaranteed Win?

 

We invite you to join us and learn how we trade our options strategies in a less risky way.

 

Start Your Free Trial

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

  • Fear of Options Assignment

    One of the most common fears in option trading is one of early assignment.  The fear of having a large number of shares (or a large short position) coupled with a potential margin call (or Reg-T call) causing a sudden shortage of cash in their accounts worries investors.  Investors commonly view assignment as a huge potential risk.

    By cwelsh,

    • 0 comments
    • 128 views
  • The Value of Equity Asset Class Diversification

    This investing lesson is a tale of two time periods that highlight the important role of equity asset class diversification and systematic rebalancing in an equity fund portfolio.  Human nature is a failed investor, when our natural instinct is often to do the exact opposite of what we should do in practice.

    By Jesse,

    • 0 comments
    • 124 views
  • Lessons from Bill Ackman's comeback

    Bill Ackman is an American investor, hedge fund manager and philanthropist. He is the founder and CEO of Pershing Square Capital Management, a hedge fund management company. Ackman is considered by some to be a contrarian investor but considers himself an activist investor.

    By Kim,

    • 0 comments
    • 480 views
  • Exercise Risk of Uncovered Calls

    Exactly how risky are uncovered calls? That depends … Some traders avoid uncovered calls altogether because the risk can be significant, even unlimited (in theory). Others can rationalize this strategy as only moderately risky based on how you pick expiration and strike.

    By Michael C. Thomsett,

    • 0 comments
    • 177 views
  • Cash is (no longer) Trash

    According to www.bankrate.com, the current national average interest rate on bank savings accounts is only 0.10%. Many banks have barely budgeted on increasing interest rates even as the risk-free rate of return on a US Treasury Bill is currently in excess of 2%. This spread is a substantial profit margin for banks.

    By Jesse,

    • 0 comments
    • 271 views
  • The Danger of False Signals

    Everyone has heard about the troubling “false signals,” a price-based reversal indicator that shows up but does not lead to reversal. This is frustrating and expensive, but the problems in how traders react to false signals can be managed effectively with a few techniques.

    By Michael C. Thomsett,

    • 0 comments
    • 347 views
  • How Earnings Impact Options Prices

    Yesterday I closed our SE May 22.5 buy-write for a couple of reasons. First off, I knew that the position only had ~$0.20 more to gain over the next three weeks. I also knew those gains would take some time to capture as out-of-the-money puts (which is essentially what the May 22.5 buy-write is) hold their value until right before expiration.

    By Jacob Mintz,

    • 0 comments
    • 228 views
  • Options in the Media

    In general, financial reporting is a scam.  The daily highlights of “President Trump had eggs for breakfast causing futures traders to worry as markets decline slightly” or “Markets up on Mickey Mouse’s birthday,” always amaze me at the abject lack of correlation. 

    By cwelsh,

    • 0 comments
    • 290 views
  • Steady Momentum ETF Portfolio

    Last May, I wrote an article about how to analyze an investment strategy. Today I’ll use the concepts from that article to explain how the Steady Momentum ETF Portfolio (available as a bonus strategy to Steady Momentum subscribers) meets the criteria described in that article.

    By Jesse,

    • 0 comments
    • 427 views
  • Where to Find Exceptional Trading Data?

    Options traders are “data wonks,” meaning we all rely on information to make what we hope are informed decisions. But how do you know the difference between valuable and reliable data on the one hand, and rumor or speculation on the other?

    By Michael C. Thomsett,

    • 0 comments
    • 479 views

  Report Article

We want to hear from you!


Yes. We played post-earnings calendars couple of times. But I found it much less consistent and more risky than the strategies we employ currently.

Share this comment


Link to comment
Share on other sites

Hi Kim,

Thank you so much for the information. As a novice options trader, I learned the hard way not to hold a straddle through earnings after getting hit with IV crush for the first time(they don't teach that in undergrad business school!) I have a question regarding timing our entry into the position. You recommend 5-7 days prior to earnings. Is this actual days or market trading days? I imagine this would make a difference in our expected return. Otherwise, I plan to sell the day before earnings on stocks that popped at least 5% in the past with the option expiring 2 weeks after announcement. Anything else a novice should keep in mind? Thanks again for the fantastic articles!

Share this comment


Link to comment
Share on other sites

One more follow up! As an example, say after looking at upcoming earnings I decide to do this with eBay. Isn't the open interest and volume too low on the Feb 10 weeklys? ebay question.PNG

ebay question.PNG

Share this comment


Link to comment
Share on other sites

Thank you for your comments.

I'm usually referring to calendar days. But this is really just an estimate. Sometimes we enter 2 weeks before earnings, sometimes just 1-2 days. it depends on the stock, on the prices etc. We do extensive backtesting to determine which stocks to use and how long in advance to enter.

Regarding your second question - yes, sometimes weeklys are not liquid enough and you need to use monthlies. It really depends on the stock. Some stocks don't have big OI, but still are easy enough to trade even on weeklys. 

Share this comment


Link to comment
Share on other sites

Very interesting.  I have been doing just the call side of your strangle trade and have had good results. Any thoughts on an upward bias going into earnings?

Share this comment


Link to comment
Share on other sites

It can definitely be done, we just prefer to stay delta neutral. Doing calls only would be much more risky and speculative trade.

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