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$TSLA, $LNKD, $NFLX, $GOOG: Thank You, See You Next Cycle
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Kim, in General Board
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By StepBack
Hello Forum,
I'm new so please pardon me for not choosing the right sub. I do have data from options with different Strike prices, times to maturity & IV. I thought that a longer time to maturity ceteris paribus always results in a higher IV. However, I fount in the data that if the strike is significantly lower than the underlying, then the IV is higher for shorter times to maturity. Can someone explain to me why that is the case?
Thank you very much!
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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!
If you want to learn more how to use it (and many other profitable strategies):
Start Your Free Trial
Related Articles:
How We Trade Straddle Option Strategy
Long Straddle: A Guaranteed Win?
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Long Straddle: A Guaranteed Win?
How We Made 23% On QIHU Straddle In 4 Hours
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By Pat Crawley
What is IV Crush?
I liken IV crush to a concert venue two hours after the headliner finishes their set. If it’s not closed, very few people are still in the building. In the hours leading to the concert, more and more people entered the venue at an increasing rate. There’s a decent showing for the openers, more viewers for the co-headliner, and then everyone who has a ticket is in the building by the time the headliner gets on stage.
But as soon as the show ends, the building empties out.
The same thing in option prices in the lead-up to the announcement of an earnings report or other significant catalyst. Traders pay for a ticket (an option) to watch the concert (earnings report). Once the company’s done reporting, they pack up and go home (option prices go back to normal).
Oftentimes, even if a stock misses earnings expectations and the stock declines, IV crush will still occur, which makes little sense. However, you have to understand that uncertainty about the report is one of the primary reasons that IV gets elevated prior to a report, so even a bad report that leads to a price decline still gives investors piece of mind that they know where the company stands.
Implied Volatility
Let’s just get clear on what implied volatility is. IV is the market’s estimation of future volatility determined by market prices. Essentially, using the price of an option, you can reverse engineer what the market is forecasting the expected move to be.
When implied volatility is high that means option traders are paying up for options in the expectation of a large move, like an earnings beat or miss.
A Hypothetical Trade to Demonstrate IV Crush
Imagine we’re trading Netflix (NFLX) earnings. Perhaps they just released their biggest hit show in history, by a long shot. Many analysts and traders alike are betting that Netflix will show huge subscriber growth this quarter. Many of them are buying call options to potentially profit from Netflix stock rising on the good news.
But those speculating on Netflix earnings have to buy their options from someone. On the other side of that trade is usually a market maker, who is just there to provide liquidity and try to make a one tick profit on each trade. The market makers also know about the potential for Netflix to have a blockbuster earnings report, so they start charging more for their call options.
Some skeptical hedge fund managers come out of the fray and begin buying put options on Netflix because they think subscriber growth has peaked, and the talk of a blockbuster quarter is hype from retail traders. The market makers have to start charging more for puts too. The more uncertain they are, the higher a premium they need to take on risk.
Through a less-simplified-version of this process is how the implied volatility of options gets so high prior to an earnings report. Everyone knows stocks make big moves after earnings and there’s no free lunch in financial markets so of course market prices reflect this reality.
Fast forward, Netflix releases their earnings, the numbers are good but not great. The stock hardly moves, and perhaps even slightly declines as the market expected better. That unknown variable of earnings is now known, so there’s no justification for high implied volatility now. Option prices decline and earnings speculators experience losses, often even if they were marginally correct on the trade idea.
IV Crush Example
GOOGL was expected to announce earnings on Feb.2 2023. The options market expected 7.4% move (the price of the ATM long straddle. Options IV on Feb.2 was 178%.
You can calculate a stock’s implied move by determining the price of a straddle for the closest expiration after earnings. The straddle is the market’s expectation, or implied move, for the stock. For example, if a stock is trading at $100 the day before its earnings announcement and the combined price of an at-the-money (ATM) call and put is $5, the stock’s expected move is $5 or 5%. If the stock moves less than $5 in either direction after earnings, then the actual move of the stock was less than the implied move.
With GOOGL trading around $107.60 before the close, traders could buy the 107/108 long strangle, betting that the stock will move more than the Implied Move.
Fast forward to the next day - GOOGL moved only 3%, the options IV collapsed 150% and the strangle has lost almost 70%.
Remember: nobody can predict how much the stock will move after earnings. The only certain thing is IV crush.
Profit From IV Crush
It stands to follow that if habitual buyers of earnings volatility consistently lose, then the traders on the other side of their trades should consistently win. To an extent, this is true. But it’s not enough on its own.
If we think about IV crush, it’s the market overreacting to future uncertainty about a catalyst like earnings. They’re scared of volatility and will make a -EV bet (buying an earnings at a high IV) to mitigate that edge. Or maybe they’re just speculating on earnings, which is quite popular post-2020.
These are textbooks markers to a good trade. You have a counterparty that is trading for a reason other than to maximize gains and intentionally making a fundamentally poor trade.
But there’s a caveat to all of this. Earnings (and other events that lead to IV crush) are actual volatility events. Stocks routinely make big gaps on earnings! It’s easy to forget this when you’re in the weeds figuring out how to exploit IV crush--but the IVs are high for a reason, and realized volatility is routinely near or in excess of the IVs.
So, you can profit by taking the other side of the trade (selling options instead of buying them). But this is a very risky strategy because if the stock moves more than expected, you might face significant losses. So it’s not a layup trade. Like nearly any trade, you have to pick your spots tactically.
The bottom line
A volatility crush is an opportunity for traders to take advantage of a pattern of predictable price movement across the options market. When you understand premium rates increasing during a substantial event (like earnings) followed by the decrease in implied volatility, you can make smarter trades, informed positions, and better moves for your overall account.
For any trader, implied volatility (IV) is one of the most important considerations because it has a direct impact on pricing. It’s even more important now as IV spreads have grown significantly wider, and the concept of a “volatility crush” has become an increasingly viable options trading strategy. Implied volatility increases significantly before an earnings announcement and this increase is due to option writers who want to ensure adequate protection of their portfolios from significant price fluctuations in the market.
Like this article? Visit our Options Education Center and Options Trading Blog for more.
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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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How We Trade Straddle Option Strategy Exploiting Earnings Associated Rising Volatility Buying Premium Prior To Earnings - Does It Work? Can We Profit From Volatility Expansion Into Earnings? Long Straddle: A Guaranteed Win? Straddle, Strangle Or Reverse Iron Condor (RIC)? How We Made 23% On QIHU Straddle In 4 Hours Why We Sell Our Straddles Before Earnings Selling Strangles Prior To Earnings How To Calculate ROI On Credit Spreads Straddle Option Overview Long Straddle Through Earnings Backtest Straddles - Risks Determine When They Are Best Used The Gut Strangle Long And Short Straddles: Opposite Structures -
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.
Those stocks are among the worst candidates for a straddle option strategy. In fact, they are so bad that they became our best candidates for a calendar spread strategy (which is basically the opposite of a straddle strategy). Here are our results from trading those stocks in the recent cycles:
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?
The results speak for themselves. We booked 147% ROI in 2014 and 32% ROI so far in 2015. All results are based on real trades, not some kind of hypothetical or backtested random study.
Related Articles:
How We Trade Straddle Option Strategy
How We Trade Calendar Spreads
Buying Premium Prior to Earnings
Can We Profit From Volatility Expansion into Earnings
Long Straddle: A Guaranteed Win?
Why We Sell Our Straddles Before Earnings
The Less Risky Way To Trade TSLA
If you want to learn more how to use our profitable strategies and increase your odds:
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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.
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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!
Related Articles:
How We Trade Straddle Option Strategy
Can We Profit From Volatility Expansion into Earnings
Long Straddle: A Guaranteed Win?
Why We Sell Our Straddles Before Earnings
Long Straddle: A Guaranteed Win?
How We Made 23% On QIHU Straddle In 4 Hours
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By Kim
Consider selling strategies when options are being traded at high implied volatility levels.
Consider buying strategies when options are being traded at low implied volatility levels.
The following infographic explains some of the aspects of the Implied Volatility:
1. What is Implied Volatility?
2. 2 types of volatility.
3. How options are affected by Implied Volatility?
And more.
We invite you to join us and learn how we trade our options strategies.
Join Us
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By Kim
Implied volatility increases when the market is bearish. On the other hand, it decreases when the market is bullish.
Implied volatility can be derived from the cost of the option. If there are no options traded on a given stock, there would be no way to calculate implied volatility. If there is an increase in implied volatility after a trade has been placed, the price of options generally increases. This is good for the option owner whereas bad for the option seller. If implied volatility decreases after the trade is placed, the price of options also decreases. This is good for the option seller and bad for the option owner.
In order to know more about implied volatility, please refer the given infographic.
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