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

  • 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
    • 150 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
    • 120 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
    • 668 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
    • 613 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
    • 1,276 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
    • 784 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
    • 1,745 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
    • 809 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
    • 2,367 views
  • What Trading Can Offer To A Newcomer

    For any first-time investor, one of the most important questions to ask is “why are you doing this?”. Getting into investment can be thrilling and open up new worlds for you, but it can also be draining both physically and emotionally, with long days and sudden market moves always a genuine risk.

    By Kim,

    • 0 comments
    • 999 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