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Kim

How NOT to Trade $NFLX Earnings

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NFLX announced earnings today after the close. Couple hours before the market close, I got a following trade alert from one of options sites I follow:

Trade: SELL -1 IRON CONDOR NFLX 100 APR 15 520/522.5/427.5/425 CALL/PUT @.91 LMT [TO OPEN/TO OPEN/TO OPEN/TO OPEN]

Trade Explanation: For the Volatility Advisory in NFLX, we are selling the Apr 427.5 puts and 520 calls and buy the Apr 425 puts and 522.5 calls for a net credit of $0.91 to open.

Underlying Price: $474.22

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My thoughts exactly, pre earnings volatility levels often give rise to 4 - 6 x the normal daily estimated move on many popular stocks so relying on volatility crush alone without consideration for the price move is a futile strategy.

 

A safer approach used by some, is to sell an unbalanced butterfly (i.e. a short butterfly) with a narrow gap in the profit zone ATM, despite having long vega, it at least offers protection provided the move is significant.

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    • By Kim
      The study was done today - here is the link. The parameters of the study:
      Use AAPL and GMCR as underlying. Buy a ATM straddle option 20 days before earnings. Sell it just before the announcement. The results of the study, based on 48 cycles (2009-2014)
      AAPL P/L: -$2933 GMCR P/L: -$2070 Based on those results, they declared (once again) that buying a straddle before earnings is a losing strategy.
       
      What's wrong with this study?
      Dismissing the whole strategy based on two stocks is completely wrong. You could say that this strategy does not work for those two stocks. This would be a correct statement. Indeed, we do not use those two stocks for our straddles strategy. From our experience, entering 20 days before earnings is usually not the best time. On average, the ideal time to enter is around 5-10 days before earnings. This when the stocks experience the largest IV spike. But it is also different from stock to stock. The study does not account for gamma scalping. Which means that if the stock moves, you can adjust the strikes of the straddle or buy/sell stock against it. Many times the stock would move back and forward from the strike, allowing you to adjust several times. In addition, the study is probably based on end of day prices, and from our experience, the end of day price on the last day is usually near the day lows, and you have a chance to sell at higher prices earlier. The study completely ignores the straddle prices. We always look at prices before entering and compare them to previous cycles. Entering the right stocks at the right time at the right prices is what gives this strategy an edge. Not selecting random stocks, random timing and ignoring the prices.
       

       
      As a side note, presenting the results as dollar P/L on one contract trade is meaningless. GMCR is trading around $150 today, and pre-earnings straddle options cost is around $1,500. In 2009, the stock was around $30, and pre-earnings straddle cost was around $500. Would you agree that 10% gain (or loss) on $1,500 trade is different than 10% gain (or loss) on $500 trade? The only thing that matters is percentage P/L, not dollar P/L.
       
      Presenting dollar P/L could potentially severely skew the study. For example, what if most of the winners were when the stock was at $30-50 but most of the losers when the stock was around $100-150?
       
      Tom Sosnoff and Tony Battista conclude the "study" by saying that "if anybody tells you that you should be buying volatility into earnings, they really haven't done their homework. It really doesn't work".
       
      At SteadyOptions, buying pre-earnings straddle options is one of our key strategies. Check out our performance page for full results. As you can see from our results, the strategy works very well for us. We don't do studies, we do live trading, and our results are based on hundreds real trades.
       
      Of course the devil is in the details. There are many moving parts to this strategy:
      When to enter? Which stocks to use? How to manage the position? When to take profits? And much more.
       
      So we will let tastytrade to do their "studies", and we will continue trading the strategy and make money from it. After all, as one of our members said, someone has to be on the other side of our trades. Actually, I would like to thank tastytrade for continuing providing us fresh supply of sellers for our strategy!
       
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    • By Pat Crawley
      They're selling options to traders looking for big wins, and when those options expire worthless, the seller of the option gets to keep the premium he collected.
       
      Many traders use these spreads to trade range-bound markets, where there’s a sustained technical range with well-defined support and resistance levels. These are winning trades should the market remain within the defined range through the life of the trade.
       
      While Iron Condors and Iron Butterflies both take advantage of the same market dynamics, there are situations where it makes sense to use one over the other.
       
      Selling Options: Shorting Volatility
      Both Iron Condors and Iron Butterflies are non-directional, limited risk option spreads. Instead of trying to profit by being bullish or bearish, these option spreads are tools to make money from options you think will expire worthless.
       
      If you had the chance to look at the options market during the GameStop madness in 2021, you witnessed insane option prices. So many traders wanted to bet against the stock but didn't want to get destroyed in a short squeeze, so they preferred to buy puts. This made put options insanely expensive to the point where you could be right on the trade and still lose money.
       
      As a result, selling puts was a prevalent strategy to take advantage of overpriced options. These situations occur every day to varying degrees.
       
      When you short an option, you're selling it to another buyer. For example, let's say you sell a call with a strike price of $20 on a $15 stock for $1. The stock is still at $15 at expiration, and the option expires worthless. You get to keep the entire $1.
       
      It's well-known that most options expire worthless, so this is a compelling trade to many traders. However, the downside is your unlimited risk when shorting options. Suppose the stock in the example above was $30 at expiration. The option is now worth $15, and you're $14 in the hole.
       
      For this reason, many traders use spreads like Iron Condors and Iron Butterflies to cap their downside. These spreads involve shorting options but buying further OTM options to limit risk.
       
      What is an Iron Condor?
      If you're familiar with other options spreads, an iron condor combines a short vertical call spread and a short vertical put spread. Put another way, it's a short strangle where you buy "wings" (OTM options) to cap your downside.
       
      If you're unfamiliar with the dictionary full of the lingo we options traders use, an Iron Condor involves shorting an out-of-the-money (OTM) put and call and buying a further OTM put and call.
       
      These extra OTM options we buy are used to cap our downside. Because shorting options comes with an unlimited downside, the Iron Condor has the benefits of shorting options with the added benefit of limiting our downside.

      An iron condor is an option spread that involves using options to profit from a stock staying within a certain price range. Put simply, the iron condor enables traders to make profits even when a stock doesn’t move at all.
       
      The iron condor is composed of four options, a long put and call, and a short put and call. Here’s an example of an iron condor spread:
      BUY (1) 394 PUT SELL (1) 400 PUT SELL (1) 420 CALL BUY (1) 426 CALL
        As you can see, you’re selling an inner options spread, and protecting the unlimited loss by buying cheap out-of-the-money (OTM) “wings” that backstop the losses if your trade idea is wrong.
       
      Here’s what the payoff diagram for this trade looks like:



       
      The goal of this option spread is for the underlying stock price to remain within the range you define with your short strikes. Because we’re selling a $400 strike put and $420 strike call, we want the stock to trade within that price range. Should it remain inside this range, we make our maximum profit at expiration because the options expire worthless.
       
      However, as you can see, our long OTM options cap our downside, mitigating the biggest risk of selling options: the unlimited losses. Of course, because there’s no free lunch, this costs us money because we have to buy options that we hope ultimately expire worthless.
       
      Characteristics of the Iron Condor
      The Iron Condor is Market Neutral
      The iron condor is market neutral, meaning it doesn’t take a directional price view, and instead profits from the lack of directional price movement. Traders often refer to this characteristic as “short volatility” because you’re betting that the stock price will move less than the options market is pricing in.
       
      You would use an iron condor when you expect the underlying stock to stay within a tight trading range and not bounce around a lot.
       
      The Iron Condor is a Theta Decay Strategy
      Because iron condors collect a net credit and are hence net short options, it is a positive theta strategy, meaning it benefits from the passage of time.
       
      Iron Condor Payoff and P&L Characteristics
      Iron condors have limited maximum profit potential as well as a limited maximum loss.
       
      The maximum profit is equivalent to the net credit collected from initiating the trade. You can easily calculate this by subtracting the cost of your long OTM wings from your short options.
       
      Let’s use our previous example:
      BUY (1) 394 PUT @ 2.28 SELL (1) 400 PUT @ 3.20 SELL (1) 420 CALL @ 3.45 BUY (1) 426 CALL @ 1.47  
      First, let’s sum the prices of our short options.
       
      Our 400 put costs $3.20 and our $420 call costs $3.45, meaning we collect $6.65 for selling these two options.
       
      Then, we simply add together the price of our long options, giving us a debit outlay of $1.47 + $2.28 = $3.75.
       
      Now we just subtract the debit from our credit to find our net credit, $6.65 - $3.75 = $2.90. Our maximum profit is $2.90
       
      The maximum loss of an iron condor is simply the “wing width” minus the net credit received. Wing width refers to the distance between the strike prices two calls or two puts. In this case, we’d just subtract the 426 call from the 420 call, giving us a wing width for $6. Now we just subtract our net credit of $2.90 giving us a max loss of $3.10.
       
      Iron Condor Pros and Cons
      Pro: Low Capital Requirements
      Because the iron condor is a limited risk strategy, you can execute it with significantly less margin than selling the equivalent short strangle (which is the same trade, except without the long OTM options capping your losses). This makes it a very popular way for undercapitalized traders to harvest premium.
       
      Pro: Structure Trades With High Probability of Profit and No Huge Downside
      Many option traders approach the market with a systematically short-volatility positioning. They’re constantly selling options and rolling them out further if the trade goes against them. This is a strategy that can print money for a long time until you’re on the wrong side of a volatility event. Many traders, like James Cordier of OptionSellers.com have blown up as a result.
       
      For this reason, some traders take a similar approach using iron condors, avoiding catastrophic losses. However, this strategy has significant drawbacks as you’re harvesting significantly less premium because you’re buying the OTM options and reducing your net credit.
       
      Con: High Commission Costs
      The iron condor requires four options per spread, making it twice as expensive to trade compared to most two-option spreads like straddles, strangles, and vertical spreads. Unlike the stock market, where commissions are zero across all retail brokers, option commissions still leave a dent in your P&L, with the standard introductory rate being $0.60/contract, which you have to pay to both open and close, bringing it to $1.20 per contract.
       
      So even for a one-lot, you’re paying $4.80 to open and close an iron condor, which is typically structured with a low maximum profit, meaning that your commissions can be a hefty percentage of your P&L when trading iron condors.
       
      Con: Less Liquidity
      The combination of requiring simultaneous execution of four different option contacts usually means it takes longer to get filled on these trades, making active trading more difficult.
       
      What is an Iron Butterfly?
      The Iron Butterfly is like an Iron Condo with a higher reward/risk ratio but a lower probability of profit.
       
      The primary difference is the short strikes. In choosing your strikes in an Iron Condor or Iron Butterfly trade, you’re defining the range you expect the underlying to remain within.
       
      Iron Condors are more forgiving, as that range is much wider. Iron Butterflies, on the other hand, short puts and calls at the same strike, making your defined range narrower and making it less likely that you'll profit on the trade. You will, however make more money if you're right on the trade.
       
      Iron butterflies and iron condors are sisters. They express very similar market views and are structured similarly. The primary difference in practice is that the iron butterfly is a far more precise strategy. It’s harder to be right, but if you are right, you make much more money.
       
      The iron butterfly is composed of four options: two long options and two short options at the same strike. Here’s an example:
      BUY (1) 404 Put SELL (1) 412 put SELL (1) 412 call BUY (1) 420 call  And here’s what the payoff diagram for this trade looks like:
       


       

      As you can see, the character of the trade is quite similar to the iron condor except for the fact that it has a more narrow opportunity to make profit. However, when the trade is in-the-money, the profits are much higher.
       
      So while most iron condors have relatively low reward/risk ratios and high win rates, iron butterflies are the opposite. They have a lower chance of success with a much higher reward/risk ratio.
       
      In this way, you can have the same view (the market will stay within a relatively tight range) and structure dramatically different trades around it. The iron condor will probably work out and net you a small profit, while the iron butterfly is a more confident approach giving you the chance for fatter profits.
       
      Like everything in options trading, it’s all about tradeoffs.
       
      Characteristics of the Iron Butterfly
      The Iron Butterfly is Market Neutral
      Just like the iron condor, short strangle, and short straddle, the iron butterfly has no directional price bias. It doesn’t care which direction the underlying stock moves. Instead, the iron butterfly is concerned with the magnitude of the price move. It profits when the underlying stock stays within a narrow range and doesn’t make any significant price moves.
       
      Due to the iron butterfly using just one short strike, the underlying stock must stay in a much more narrow range than with the iron condor. Whereas the iron condor has the freedom to define a wide range using a short put and call, the iron butterfly is short only one strike, leading to the cone-shaped payoff diagram.
       
      For this reason, the maximum profit is much higher with the caveat that the probability of reaching the maximum profit is far lower than that of the iron condor.
       
      In this way, the iron butterfly enables you to express a market-neutral and short-volatility market outlook with a high reward/risk ratio that would usually be a trait of a net debit strategy.
       
      The Iron Butterfly is a Theta Decay Strategy
      The goal of the iron butterfly strategy is for the short option to expire worthless, or at least with less value than you initially sold it for.
       
      As with any short options strategy, much of the profit comes from the stock price not moving, resulting in the option rapidly losing time value due to theta decay.

      Iron condors capitalize on the same phenomenon but with a different trade structure.
       
      The Iron Butterfly Has Limited Profit and Risk Potential
      The max profit and loss math for the iron butterfly is quite similar to that of the iron butterfly.
       
      The max profit is the net credit received when opening the position
       
      The max loss math works similarly to simply shorting a call or put. The further away the stock is from the strike price, the more the losses build until your long option hedges kick in and cap the losses.
       
      Iron Butterfly Pros and Cons
      Pro: Short Volatility With High Reward/Risk Ratio
      In general, market-neutral strategies that capitalize on theta decay tend to have poor reward/risk ratios, only making up for this drawback with a high win rate. The iron butterfly turns this on its head and instead has a much lower win rate than traditional short-volatility strategies with a higher reward/risk ratio, giving you the potential for asymmetric profits.
       
      Pro: Selling Options With Limited Risk
      For many traders who lean towards selling premium, the potential for unlimited, catastrophic losses keeps them up at night. Despite the low probability of an extreme price move, black swans seem to creep up more than anyone expects.
       
      The iron butterfly allows traders to mimic the payoff structure of simply selling a put or call while capping losses with long options on either side of their short option strike.
       
      Con: Narrow Range of Profitability
      An iron butterfly has a narrow range of profitability compared to the iron condor because there is only one short strike. This means there’s a far greater margin of error for strike selection, whereas the iron condor allows you to choose two strikes and define as wide of a range as you’d like.
       
      Summary
      Iron Condors are made up of both a short vertical spread and a short vertical put spread.



      Iron Butterflies are made up of two short options at the same strike and two long "wings" that protect your downside. 
       


      Remember that option spreads are trade constructions, not trade strategies. There's no inherent edge in trading Iron Condors or Iron Butterflies. They're just tools to apply to market dynamics where its more likely for markets to stay range-bound.
       
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    • By Kim
      As a reminder, a strangle involves buying calls and puts on the same stock with different strikes. Buying calls and puts with the same strike is called a long straddle. Strangles usually provide better leverage in case the stock moves significantly.

      So let’s see how it works. First, you must identify stocks which have a history of big post-earnings moves. Some examples include AMZN, Netflix, Google, Priceline (PCLN), and others. Then you buy a strangle or a straddle a day or two before the earnings are announced. If the stock has a big move, you sell for a big profit.

      The problem is you are not the only one knowing that earnings are coming. Everyone knows that those 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.

      Let’s examine a few test cases from the 2011 earnings cycle.
      AKAM announced earnings on Oct. 26. The $24 straddle could be purchased for $4.08. IV was 84%. The next day the stock jumped 15%, yet the straddle was worth only $3.81. The reason? IV collapsed to 47%. The market “expected” the stock to move 17-18%, based on previous moves, but the stock moved “only” 15% and the straddle lost 7%. BIDU announced earnings on Oct. 26. The stock moved 4.5% following the earnings. You could purchase the straddle at $19.55 the day before earnings. The same straddle was worth $13.47 the next day. That’s a loss of 31%. TIVO moved 2%, the straddle lost 29%. FSLR moved 3%, the straddle lost 55%. Now let’s check a couple of good trades.
      NFLX announced earnings on October 24. The stock collapsed 34.9% the next day, a move of historical proportions. The 120 strangle could be purchased the day before earnings at $24.52 and sold the next day at $43.00. That’s a 75% gain, but this is as good as it gets. This is a move of historic proportions but the trade is even not a double. AMZN straddle gained 57%. CME straddle gained 62%. GMCR straddle gained 84%. It is easy to get excited after a few trades like NFLX, GMCR, CME and AMZN. However, we have to remember that those stocks experienced much larger moves than their average move in the last few cycles. In some cases, the move was double what was expected. NFLX and GMCR moved more than 35%, the largest moves in at least 10 years. 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.
       
      Some people might argue that if the trade is not profitable the same day, you can continue holding or selling only the winning side till the stock moves in the right direction. It can work under certain conditions. For example, if you followed the specific stock in the last few cycles and noticed some patterns, such as the stock continuously moving in the same direction for a few days after beating the estimates. Another example is holding the calls when the general market is in uptrend (or downtrend for the puts).

      However, it has nothing to do with the original strategy. From the minute you decide to hold that trade, you are no longer using the original strategy. If the stock didn’t move enough to generate a profit, you must be ready to make a judgement call by selling one side and taking a directional bet. This might work for some people, but the pure performance of the strategy can be measured only by looking at a one day change of the strangle or the straddle (buying a day before earnings, selling the next day).
       
      The bottom line:

      Over time the options tend to overprice the potential move. Those options experience huge volatility drop the day after the earnings are announced. In most cases, this drop erases most of the gains, even if the stock had a substantial move.
       
      Jeff Augen, a successful options trader and author of six books, agrees:
      It doesn’t necessarily mean that the strategy cannot work and produce great results. However, in most cases, you should be prepared to hold beyond the earnings day, in which case the performance will be impacted by many other factors, such as your trading skills, general market conditions etc.

      To hedge your bets and reduce the loss if the stock doesn't move, you might consider trading a Reverse Iron Condor.

      This article was originally published here.

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    • By Kim
      However, not all stocks are suitable for that strategy. Some stocks experience consistent pattern of losses when buying premium before earnings. For those stocks we are using some alternative strategies like calendars.
       
      In one of my previous articles I described a study done by tastytrade, claiming that buying premium before earnings does not work. Let's leave aside the fact that the study was severely flawed and skewed by buying "future ATM straddle" which simply doesn't make sense (see the article for full details). Today I want to talk about the stocks they used in the study: TSLA, LNKD, NFLX, AAPL, GOOG.
       
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      TSLA: +28%, +31%, +37%, +26%, +26%, +23% LNKD: +30%, +5%, +40%, +33% NFLX: +10%, +20%, +30%, +16%, +30%, +32%, +18% GOOG: +33%, +33%, +50%, -7%, +26%  
      You read this right: 21 winners, only one small loser.
       
      This cycle was no exception: all four trades were winners, with average gain of 25.2%.
       
      I'm not sure if tastytrade used those stocks on purpose to reach the conclusion they wanted to reach, but the fact remains. To do a reliable study, it is not enough to take a random list of stocks and reach a conclusion that a strategy doesn't work.
       
      At SteadyOptions we spend hundreds of hours of backtesting to find the best parameters for our trades:
      Which strategy is suitable for which stocks? When is the optimal time to enter? How to manage the position? When to take profits?  
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    • By Pat Crawley
      It's a core tenant of how options are priced, and it's often the trader with the most accurate volatility forecast who wins in the long term.
       
      Whether you like it or not, you're taking an inherent view on volatility anytime you buy or sell an option. By purchasing an option, you're saying that volatility (or how much the options market thinks the underlying will move until expiration) is cheap, and vice versa.
       
      With volatility as a cornerstone, some traders prefer to do away with forecasting price directionality entirely and instead trade based on the ebbs and flows of volatility in a market-neutral fashion.
       
      Several option spreads enable such market-neutral trading, with strangles and straddles being the building blocks of volatility trading.
       
      But even though straddles and strangles are the standards, they sometimes leave something to be desired for traders who want to express a more nuanced market view or limit their exposure.
       
      For this reason, spreads like iron condors and butterflies exist, letting traders bet on changes in options market volatility with modified risk parameters.
       
      Today, we’ll be talking about the iron condor, one of the most misunderstood options spreads, and the situations where a trader may want to use an iron condor in favor of the short strangle.
       
      What is a Short Strangle?
      Before we expand on the iron condor and what makes it tick, let's start by going over the short strangle, a short-volatility strategy that many view as the building blocks for an iron condor. An iron condor is essentially just a hedged short strangle, so it's worth understanding them.
       
      A strangle comprises an out-of-the-money put and an OTM call, both in the same expiration. A long strangle involves buying these two options, while a short strangle involves selling them. The goal of the trade is to make a bet on changes in volatility without taking an outright view on price direction.
       
      As said, strangles and straddles are the building blocks for options volatility trading. More complex spreads are constructed using a combination of strangles, straddles, and "wings," which we'll explore later in the article.
       
      Here’s an example of a textbook short strangle:
       

       
      The goal for this trade is for the underlying to trade within the 395-405 range. Should this occur, both options expire worthless, and you pocket the entire credit you collected when you opened the trade.
       
      However, as you can see, you begin to rack up losses as the market strays outside of that shaded gray area. You can easily calculate your break-even level by adding the credit of the trade to each of your strikes.
       
      In this case, you collect $10.46 for opening this trade, so your break-even levels are 415.46 and 384.54.
       
      But here's where the potential issue arises. As you can see, the possible loss in this trade is undefined. Should the underlying go haywire, there's no telling where it could be by expiration. And you'd be on the hook for all of those losses.
       
      For this reason, some traders look to spreads like the iron condor, which lets you bet on volatility in a market-neutral fashion while defining your maximum risk on the trade.
       
      Iron Condors Are Strangles With “Wings”
      Iron condors are market-neutral options spreads used to bet on changes in volatility. A key advantage of iron condors is their defined-risk property compared with strangles or straddles. The unlimited risk of selling strangles or straddles is
       
      Iron condors are excellent alternatives for traders who don't have the temperament or margin to sell straddles or strangles.
       
      The spread is made up of four contracts; two calls and two puts. To simplify, let's create a hypothetical. Our underlying SPY is at 400. Perhaps we think implied volatility is too high and want to sell some options to take advantage of this.
       
      We can start by constructing a 0.30 delta straddle for this underlying. Let's use the same example: selling the 412 calls and the 388 puts. We're presented with the same payoff diagram as above. We like that we're collecting some hefty premiums, but we don't like that undefined risk.
       
      Without putting labels on anything, what would be the easiest way to cap the risk of this straddle? A put and a call that is both deeper out-of-the-money than our straddle. That's pretty easy. We can just buy further out-of-the-money options. This is all an iron condor is, a straddle with "wings."
       
      Another way of looking at iron condors is that you’re constructing two vertical credit spreads. After all, if we cut the payoff diagram of an iron condor in half, it’s identical to a vertical spread:
       

       
      Here’s what a standard iron condor might look like when the underlying price is at 400:
      ●     BUY 375 put
      ●     SELL 388 put
      ●     SELL 412 call
      ●     BUY 425 call
       
      The payoff diagram looks like this:
       

       
      The Decision To Use Iron Condors vs. Short Strangles
      Ever wonder why the majority of professional options traders tend to be net sellers of options, even when on the face of things, it looks like you can make huge home runs buying options?
       
      Many natural customers in the options market use them to hedge the downside in their portfolios, whether that involves buying puts or calls.
       
      They essentially use options as a form of insurance, just like a homeowner in Florida buys hurricane insurance not because it's a profitable bet but because they're willing to overpay a bit for the peace of mind that their life won't be turned upside down by a hurricane.
       
      Many option buyers (not all!) operate similarly. They buy puts on the S&P 500 to protect their equity portfolio, and they hope the puts expire worthless, just as the Florida homeowner prays they never have actually to use their hurricane insurance.
       
      This behavioral bias in the options market results from a market anomaly known as the volatility risk premium. All that means is implied volatility tends to be higher than realized volatility. And hence, net sellers of options can strategically make trades to exploit and profit from this anomaly.
       
      There's a caveat, however. Any source of returns that exists has some drawback, a return profile that perhaps isn't ideal in exchange for earning a return over your benchmark. With selling options, the risk profile scares people away from harvesting these returns.
       
      As you know, selling options has theoretically unlimited risk. It's critical to remember that when selling a call, you're selling someone else the right to buy the underlying stock at the strike price. A stock can go up to infinity, and you're on the hook to fulfill your side of the deal no matter how high it goes.
       
      So while there can be a positive expected value way to trade from the short side, many aren’t willing to take that massive, undefined risk.
       
      And that's where spreads like the Iron Condor come in. The additional out-of-the-money puts and calls, often referred to as 'wings,' cap your losses, allowing you to short volatility without the potential for catastrophe.
       
      But it's not a free lunch. You're sacrificing potential profits to assure safety from catastrophic loss by purchasing those two OTM options. And for many traders, this is too high a cost to harvest the VRP.
       
      In nearly any, backtest or simulation, short strangles come up as the clear winner because hedging is generally -EV. For instance, take this CBOE index that tracks the performance of a portfolio of one-month .15/.05 delta iron condors on SPX since 1986:
       

       
      Furthermore, there's the consideration of commissions. Iron condors are made up of four contracts, two puts, and two calls. This means that iron condor commissions are double that of short strangles under most options trading commission models.
       
      With the entry-rate retail options trading commission hovering around $0.60/per contract, that’s $4.80 to open and close an iron condor.
       
      This is quite an obstacle, as most iron condors have pretty low max profits, meaning that commissions can often exceed 5% of max profit, which has a big effect on your bottom line expected value.
       
      Ultimately, it costs you in terms of expected value and additional commissions to put on iron condors. So you should have a compelling reason to trade iron condors in favor of short strangles.  
       
      Bottom Line
      Too many traders get stuck in the mindset of "I'm an iron condor income trader" when the market is far too chaotic and dynamic for such a static approach. The reality is that there's an ideal strategy for risk tolerance at a given time, in a given underlying.
       
      Sometimes the overall market regime calls for a short-volatility strategy, while others call for more nuanced approaches like a calendar spread.
       
      There are times when it makes sense to trade iron condors when implied volatility is extremely high, for instance. High enough that any short-vol strategy will print money, but too high to be naked short options. Likewise, there are times when iron condors are far from the ideal spread to trade. 

      Another comparison is Iron Condor Vs. Iron Butterfly

      Like this article? Visit our Options Education Center and Options Trading Blog for more.

      Related articles
      Selling Naked Strangles: The Math Selling Short Strangles And Straddles - Does It Work? Trading An Iron Condor: The Basics Low Premium Iron Condors Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Comparing Iron Condor And Iron Butterfly Butterfly Spread Strategy - The Basics Iron Condor Vs. Iron Butterfly  
    • By cwelsh
      Such lawsuits are common and typically lack merit because offering documents are properly drafted to protect the companies involved and disclose the risk.

      I find it unlikely that the documents were not properly drafted.  For instance, in one of the few actual UBS documents I could find on UBS’s yield enhancement strategies provided “yield enhancement strategy products are designed for investors with moderate risk tolerance who want to enhance the low to moderate return typically generated in a ‘flat’ or ‘sideways’ market.” That’s a great description for trading iron condors. 

      So, if the documents were fine (most likely, but you never know), what was the issue?Most likely overzealous brokers pushed the strategy without really understanding the risk profile. 

      My takeaway from reading about this is two part.  First, investors typically don’t understand options, and the media certainly does not.  Most advisors do not either.  For instance, the media has called the strategy used by UBS a “leveraged, esoteric options strategy.”  Iron condors are neither esotericor typically leveraged.  They are the definition of a defined risk option strategy.  A profit/loss graph of an iron condor looks like:
       
       
       
      There is a maximum loss on any single trade that can be controlled based on the strikes and premiums received.  UBS’s strategy purportedly used iron condors on the S&P 500 index, the NASDAQ, and other “primary” market indexes – so volume should not have been an issue. 
       
      Other writers have demonstrated their ignorance of the strategy.  One popular critique of the UBS strategy reads:
       
      “The problems with YES began in 2018 with violent fluctuations in the S&P 500…The most volatile period was between October and December 2018, during which time the market declined 20%--then followed by a rebound of 12% through January 2019. The violent swings caused the premiums of both the put and call side of the iron condor strategy to spike, leading to losses on both sides of the trade.”
       
      But this is practically impossible.  An investor can’t experience losses on BOTH sides of the graph (in effect doubling the losses), unless the traders are idiots.  The only way to have that happen is to close out one half of the trade for a loss, in the hopes that the profits on the other side will increase, but then the market whipsaws back, thus causing losses on both sides. 
       
      Of course, at this point, the strategy is no longer an iron condor.  It’s a simple vertical spread:
       

       
      The odd thing about this critique is that even vertical spreads have loss limits.  Let’s say the UBS traders had a maximum loss rate of ten percent.  A structured iron condor can have a max loss of ten percent the same as a vertical spread. 
       
      If the traders are trading to profit from time decay across multiple indexes, risk could be further controlled through the use of reverse iron condors that have a profit and loss graph of:
       

       
      In the event of a large move, such a position could help offset losses.  (There are other ways to protect against such a move as well – anything from simply buying long dated out of the money puts and calls to trading volatility instruments). 
       
      The problem with a normal iron condor in a low volatility market is that traders do not receive a very high premium for the risk they take.  In order to get a 1% or 2% return per month, UBS traders would have to be taking risks that were outside of the “moderate” or “low” range. Traders probably started taking chances they shouldn’t have.
       
      Much of the media has commented that the UBS traders “compounded” their results by trying to “make up” for losses after blowing up trades.  (Who of us hasn’t done that?)   Traders make trade adjustments or open new trades on the prediction that either (a) the price will return to the mean or (b) the price will continue moving.  It appears the UBS traders made the bet that the price would continue moving, and instead it reverted to the mean.
       
      Of course,when traders do that, they are no longer trading risk defined iron condors.  They are making directional market bets – bets that if wrong, make the situation worse.
       
      What can we, as option traders, learn from this?
      Trading is as much psychological, as it is methodical, even for supposed professionals.  Losses will occur and decisions will be made trying to “make up” for losses rather than staying within stated trading guidelines.  This is a mistake.  Plan trades, plan for what happens when the trades go wrong, and when they do go wrong, stick to the plan.  Sure you might occasionally “fix” what went wrong, but more often than not, you’ll likely make the situation worse; The general public views option as “high risk” investments.  They are not, when handled properly.  In fact, as option traders know, options can be used to mitigate risk.  Try to combat the disinformation when you can; Don’t trust plaintiff class action lawyers.   
      I personally do not understand all of the class type legal advertising that exists because of  the strategy.  By all accounts, all UBS agreements require FINRA arbitration of individual claims.  This greatly decreases the profit potential for attorneys, unless the client lost hundreds of thousands of dollars (in which case the client is probably not calling Saul from the internet for the case).  Strangely, that is what can currently be seen.

      Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Trades and Lorintine CapitalBlog.
       
    • By Kim
      About six months ago, I came across an excellent book by Jeff Augen, “The Volatility Edge in Options Trading”. One of the strategies described in the book is called “Exploiting Earnings - Associated Rising Volatility”. Here is how it works:
      Find a stock with a history of big post-earnings moves. Buy a strangle for this stock about 7-14 days before earnings. Sell just before the earnings are announced. For those not familiar with the strangle strategy, it involves buying calls and puts on the same stock with different strikes. If you want the trade to be neutral and not directional, you structure the trade in a way that calls and puts are the same distance from the underlying price. For example, with Amazon (NASDAQ:AMZN) trading at $190, you could buy $200 calls and $180 puts.

      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.

      Like every strategy, the devil is in details. The following questions need to be answered:
      Which stocks should be used? I tend to trade stocks with post-earnings moves of at least 5-7% in the last four earnings cycles; the larger the move the better. When to buy? IV starts to rise as early as three weeks before earnings for some stocks and just a few days before earnings for others. Buy too early and negative theta will kill the trade. Buy too late and you might miss the big portion of the IV increase. I found that 5-7 days usually works the best. Which strikes to buy? If you go far OTM (Out of The Money), you get big gains if the stock moves before earnings. But if the stock doesn’t move, closer to the money strikes might be a better choice. Since I don’t know in advance if the stock will move, I found deltas in the 20-30 range to be a good compromise. The selection of the stocks is very important to the success of the strategy. The following simple steps will help with the selection:
      Click here. Filter stocks with movement greater than 5% in the last 3 earnings. For each stock in the list, check if the options are liquid enough. Using those simple steps, I compiled a list of almost 100 stocks which fit the criteria. Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), Netflix (NASDAQ:NFLX), F5 Networks (NASDAQ:FFIV), Priceline (PCLN), Amazon (AMZN), First Solar (NASDAQ:FSLR), Green Mountain Coffee Roasters (NASDAQ:GMCR), Akamai Technologies (NASDAQ:AKAM), Intuitive Surgical (NASDAQ:ISRG), Saleforce (NYSE:CRM), Wynn Resorts (NASDAQ:WYNN), Baidu (NASDAQ:BIDU) are among the best candidates for this strategy. Those stocks usually experience the largest pre-earnings IV spikes.

      So I started using this strategy in July. The results so far are promising. Average gains have been around 10-12% per trade, with an average holding period of 5-7 days. That might not sound like much, but consider this: you can make about 20 such trades per month. If you allocate just 5% per trade, you earn 20*10%*0.05=10% return per month on the whole account while risking only 25-30% (5-6 trades open at any given time). Does it look better now?

      Under normal conditions, a 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. In some cases, the theta is larger than the IV increase and the trade is a loser. However, the losses in most cases are relatively small. Typical loss is around 10-15%, in some rare cases it might reach 25-30%. But the winners far outpace the losers and the strategy is overall profitable.

      Market environment also plays a role in the strategy performance. The strategy performs the best in a volatile environment when stocks move a lot. If none of the stocks move, most of the trades would be around breakeven or small losers. Fortunately, over time, stocks do move. In fact, big chunk of the gains come from stock movement and not IV increases. The IV increase just helps the trade not to lose in case the stock doesn’t move.

      In the next article I will explain why, in my opinion, it usually doesn’t pay to hold through earnings. We always close those trade before earnings to avoid IV crush.

      The original article was published here.
       
    • By Kim
      Here is how their methodology works:
       
      In theory, if you knew exactly what price a stock would be immediately before earnings, you could purchase the corresponding straddle a number of days beforehand. To test this, we looked at the past 4 earnings cycles in 5 different stocks. We recorded the closing price of each stock immediately before the earnings announcement. We then went back 14 days and purchased the straddle using the strikes recorded on the close prior to earnings. We closed those positions immediately before earnings were to be reported.


       

       
      Study Parameters:


      TSLA, LNKD, NFLX, AAPL, GOOG Past 4 earnings cycles 14 days prior to earnings - purchased future ATM straddle Sold positions on the close before earnings  
      The results:
      Future ATM straddle produced average ROC of -19%.
       
      As an example:
       
      In the previous cycle, TSLA was trading around $219 two weeks before earnings. The stock closed around $201 a day before earnings. According to tastytrade methodology, they would buy the 200 straddle 2 weeks before earnings. They claim that this is the best case scenario for buying pre-earnings straddles.

      My Rebuttal 
       
      Wait a minute.. This is a straddle, not a calendar. For a calendar, the stock has to trade as close to the strike as possible to realize the maximum gain. For a straddle, it's exactly the opposite:
       

       
      When you buy a straddle, you want the stock to move away from your strike, not towards the strike. You LOSE the maximum amount of money if the stock moves to the strike.
       
      In case of TSLA, if you wanted to trade pre-earnings straddle 2 weeks before earnings when the stock was at $219, you would purchase the 220 straddle, not 200 straddle. If you do that, you start delta neutral and have some gamma gains when the stock moves to $200. But if you start with 200 straddle, your initial setup is delta positive, while you know that the stock will move against you. 
       
      It still does not guarantee that the straddle will be profitable. You need to select the best timing (usually 5-7 days, not 14 days) and select the stocks carefully (some stocks are better candidates than others). But using tastytrade methodology would GUARANTEE that the strategy will lose money 90% of the time. It almost feels like they deliberately used those parameters to reach the conclusion they wanted.
       
      As a side note, the five stocks they selected for the study are among the worst possible candidates for this strategy. It almost feels like they selected the worst possible parameters in terms of strike, timing and stocks, in order to reach the conclusion they wanted to reach.
       
      At SteadyOptions, buying pre-earnings straddles is one of our key strategies. It works very well for us. Check out our performance page for full results. As you can see from our results, "Buying Premium Prior To Earnings" is still alive and kicking. Not exactly "Nail In The Coffin".
       
      Comment: the segment has been removed from tastytrade website, which shows that they realized how absurd it was. We linked to the YouTube video which is still there.
       
      Of course the devil is in the details. There are many moving parts to this strategy:
      When to enter? Which stocks to use? How to manage the position? When to take profits?  
      And much more. But overall, this strategy has been working very well for us. If you want to learn more how to use it (and many other profitable strategies):
       
      Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

      Join SteadyOptions Now!
       
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      Can We Profit From Volatility Expansion into Earnings
      Long Straddle: A Guaranteed Win?
      Why We Sell Our Straddles Before Earnings
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      How We Made 23% On QIHU Straddle In 4 Hours
    • By Kim
      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 long 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 crushes to the normal levels and the options trade much cheaper.
       

       
      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:
       

       
      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 options trading 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.
       
      Join Us
    • By Kim
      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.


      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:
      How We Trade Straddle Option Strategy Buying Premium Prior To Earnings - Does It Work? Can We Profit From Volatility Expansion Into Earnings? Long Straddle: A Guaranteed Win? Why We Sell Our Straddles Before Earnings Selling Strangles Prior To Earnings Straddle Option Overview  
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