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:

 

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

  • Should You Finance or Pay Cash for a Home?

    When buying a home, individuals who have accumulated enough wealth to pay cash or make a substantial down payment have a decision to make. Take advantage of record low interest rates and lock in a 30-year mortgage for around 2.5%? Or pay cash and make payments to yourself by investing the savings?

    By Jesse,

    • 0 comments
    • 73 views
  • Implied Volatility Collapse

    The key ingredient on expiration Friday is volatility collapse. At the beginning of that last trading day, there are more than 6 hours of trading yet to go. However, there are 38 hours left before expiration on Saturday. When volatility is high, OTM options are most likely to be overpriced.

    By Michael C. Thomsett,

    • 0 comments
    • 167 views
  • Trading Volatility: Why It Isn’t Always a Bad Thing

    Volatility is still widely misunderstood — and feared — by novice traders. As someone lacking in trading knowledge and experience, you often hear and believe horror stories of unstable markets. The fear is valid. After all, your shares and investments are at an elevated risk in an unpredictable environment.

    By Kim,

    • 0 comments
    • 169 views
  • Models and their limits

    Options traders tend to think mathematically. When considering selection of an underlying, risks and expected profits, the model of outcomes is a primary tool for making selections. Without a model how can anyone understand the differences between two or more options that might otherwise appear the same – similar moneyness, same strike, and same premium.

    By Michael C. Thomsett,

    • 0 comments
    • 177 views
  • When You've Only Got $1000 To Invest, What Do You Do?

    Are you new to the world of investments? Most likely; it’s not something you just fall into! BUt at the same time, investing can be done by anyone. Investing doesn’t need to be saved for retirement. It isn’t something only the uber rich are able to get into.

    By Kim,

    • 0 comments
    • 401 views
  • Use of Options Spreads to Reduce Risk

    Traders may view spreads as a means for reducing market risk. But this also means that the potential profit is just as limited as potential loss, and this is easily overlooked in the focus on risk alone. A realistic view of spreading is that it reduces risk in exchange for accepting limited maximum profit.

    By Michael C. Thomsett,

    • 0 comments
    • 478 views
  • Put Writing in 2020: The Role of Timing Luck

    The impact of luck can play a meaningful role in the short-term outcomes of monthly option trades due to the requirement to roll expiring contracts. The extreme volatility in 2020 highlightsthis fact when we look at results of SPY cash secured put trades launched on slightly different start dates.

    By Jesse,

    • 0 comments
    • 475 views
  • The problem of Option Math

    Option traders may be divided into two categories. First are those relying on instinct or casual observation. This group tends to speculate on directional movement, future volatility, value, and on potential profitability of trades. The second group is involved deeply with math of trading and depends on what is perceived as certainty or near certainty.

    By Michael C. Thomsett,

    • 0 comments
    • 645 views
  • Put/Call Parity: Two Definitions

    Traders hear the term put/call parity a lot, but what does it mean? There are two definitions and they are vastly different from one another. The first definition involves the net credit/debit for any combination trade, with trading costs are considered. The second definition takes assumed interest rates and present value into mind.

    By Michael C. Thomsett,

    • 0 comments
    • 535 views
  • Do Options Affect Stock Prices?

    It is widely acknowledged that the price of the underlying directly impacts the premium of the option. Therefore, options are termed derivatives. Their current value is directly derived from movement of the underlying price. Is the opposite also true? Does movement of the option value affect the underlying price?

    By Michael C. Thomsett,

    • 0 comments
    • 796 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 Expertido