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tjlocke99

Trading Weekly IV Increase Over Monthly

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Could some of the senior members and/or Kim comment on this idea?

Does the IV (when it moves at all) on weeklies always outpace or at least stay even with the monthlies on the earnings trades?

Could you then do the opposite of a calendar and long the weeklies and short the monthlies on an earnings trade?

Take this hypothetical example:

AAPL underlying @ 615

let's say its 19 July and the 27 July AAPL weekly is released. Let's say we have this made up pricing:

1. 27 July AAPL 615 Call @ $10.00

2. 27 July AAPL 615 Put @ $10.00

3. 17 Aug AAPL 615 Call @ $20.00

4. 17 Aug AAPL 615 Put @ $20.00

You would do this:

long qty 2 of #1

long qty 2 of #2 (creating a straddle)

short qty 1 of #3

short qty 1 of #4

I am sure the theta will kill you if you don't get an IV increase, so do this on a stock like AAPL probably would not work because of the high stock price (unless your portfolio is huge).

Any thoughts on a trade that could take advantage of the greater IV increase in the weeklies?

Thanks!

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my 2 cents at first glance.. Why would you want to be short either weekly or monthly if you are figuring that IV is going to increase?

The thought would be the weekly IV outpacing the monthly IV. If the monthlies are treated as naked though then its a dead end.

There certainly seem to be better strategies. Thank you very much for your feedback!

R

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      Tap Here to See the Tools at Work 

      Risk Disclosure 
      You should read the Characteristics and Risks of Standardized Options. 

      Past performance is not an indication of future results. 

      Ophir Gottlieb is the CEO & Co-founder of Capital Market Laboratories. Mr Gottlieb’s learning background stems from his graduate work in mathematics and measure theory at Stanford University and his time as an option market maker on the NYSE and CBOE exchange floors. He has been cited by Yahoo! Finance, CNNMoney, MarketWatch, Business Insider, Reuters, Bloomberg, Wall St. Journal, Dow Jones Newswire, Barron’s, Forbes, SF Chronicle, Chicago Tribune and Miami Herald and is often seen on financial television. He created and authored what was believed to be the most heavily followed option trading blog in the world for three-years.This article is used here with permission and originally appeared here.
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      The question many people ask us: are all those studies wrong? How their results are so different from our real life trading performance?

      The answer is that the studies are not necessarily wrong. They just have serous limitations, such as:
      The studies use the whole universe of stocks, while we use only a handful of carefully selected stocks that show good results in backtesting.
        The studies use certain randomly selected entry dates, while we enter only when appropriate.
        The studies use EOD (End Of Day) prices while we take advantage of intraday price fluctuations.
        The studies exit a day before earnings while we manage the trades actively by taking profits when our profit targets are hit.   This makes a world of difference.

      If you are not a member yet, you can join our forum discussions for answers to all your options questions.
       
      Here is a classic example how real trading is different from "studies".

      On March 2 2:30pm we entered CPB straddle:



      The price was 3.05 or 6.5% RV. When considering a trade, we look at the straddle price as percentage of the stock price. We call it RV (Relative Value). We based our entry on the CPB RV chart:



      We exited the trade on March 3 10:05am for $3.45 credit, 13.1% gain



      EOD price on March 2 was 3.40 and EOD price on March 3 was 2.95. The study using EOD prices would show 13.2% LOSS while our real trade was closed for 13.1% GAIN.

      Two points that contributed to the difference:
      We have a very strict criteria for entering those trades. In some cases we might wait weeks for the price to come down and meet our criteria. Based on historical RV charts, we would not even be entering this trade at 3.40.
        On the last day, we did not wait till the EOD and closed the trade in the morning when it reached our profit target. This is just one example how a "study" can show dramatically different results from real trading.

      On a related note, using a dollar P/L in a study is meaningless - this alone disqualifies the whole study. The only thing that matter is percentage amount. Why? Because in order to get objective results, you need to apply the same dollar allocation to all trades.

      For example, lets take a look on stocks like AMZN and GM. AMZN straddle can cost around $200 and GM straddle around $2. If AMZN straddle average return was -10% or -$20 and GM average return was +50% or $1, the average return should be reported as +20%. In the study, it would be reported as -$9.5.

      Don't believe everything you read. Use your common sense and take everything with a grain of salt. 

      I have a great respect for Kirk. He is one of the most honest, professional and hardworking people in our industry, but even the greatest minds sometimes get it wrong.

      Related articles:
      How We Trade Straddle Option Strategy Buying Premium Prior To Earnings - Does It Work? Can We Profit From Volatility Expansion Into Earnings? How We Made 23% On QIHU Straddle In 4 Hours Why We Sell Our Straddles Before Earnings
    • By Kim
      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
       
      Price Action: We are selling this $2.5-wide Iron Condor in the online streaming company for a credit of $0.91. For an Iron Condor trade, we sell an out-of-the-money Call Vertical (520/522.5) and Put Vertical (427.5/425) simultaneously. The company has earnings after the close and the option markets are pricing in a move of 8-9%. We expect the shares to move after the report but are giving ourselves a nice range of $92.5 between the short strikes. We need the shares to continue to trade between our break-even levels of $426.59 on the downside and $520.91 on the upside.
       
      The following was described as a rationale for the trade:
       
      Volatility: Volatility is elevated in the Apr options which makes this trade attractive. The IV percentile rank is elevated at 73% also which also gives us a good opportunity to sell this Iron Condor. We expect volatility to fall sharply after earnings which will contract the value of this short-term neutral position.
       
      Probability: There is an 80% probability that NFLX shares will be below the $520 level and a 80% probability that it will be above the $427.5 level at Apr expiration. This trade offers a good Risk/Reward scenario with the amount of credit collected vs. the probability numbers for this position.
       
      Trade Duration: We have 2 days to Apr expiration in this position. This is a short-term position and time decay will increase quickly due to the time frame and the earnings report.
       
      Logic: We want to take advantage of the increased volatility in our option by initiating this earnings play. Our short verticals are outside of the anticipated one standard deviation move that the options are pricing in so our probabilities are positive. The shares will hopefully remain between our short verticals and we will be aggressive in closing the trade.
       
      My comments:
      It is true that Volatility is elevated in the Apr options, but this is completely normal, considering the upcoming earnings and does NOT make the trade attractive.
        It is also true that volatility will fall sharply after earnings, but it is not relevant if the stock will be trading above the long strikes. In this case, the trade will still lose 100%.
        2 days to Apr expiration makes the trade much more risky because there will be no time to adjust or take any corrective action.
        "80% probability that NFLX shares will be below the $520 level" means nothing when earnings are involved. The price action will be determined by earnings only, not by options probabilities.
        "The shares will hopefully remain between our short verticals" - hope is not a strategy.
        The short strikes are less than 10% from the stock price, which is not far enough, considering NFLX earnings history.
      Now, I want you to take a look at the last 10 cycles of NFLX post-earnings moves:
       

      (This screenshot is taken from OptionSlam.com).
       
      Now, I'm asking you this:
       
      WHO IN HIS RIGHT MIND WOULD TRADE AN IRON CONDOR WITH SHORT STRIKES LESS THAN 10% FROM THE STOCK, ON A STOCK THAT HAS TENDENCY TO MOVE 15-25% AFTER EARNINGS ON A REGULAR BASIS???
       
      The stock is trading above $530 after hours. If it stays this way tomorrow, this trade will be a 100% loser, and there is NOTHING you can do about it. But frankly, the final result doesn't really matter. To me, this trade is simply insane and shows complete lack of basic options understanding.
       
      That said, I'm not completely dismissing trading Iron Condors through earnings. For many stocks, options consistently overestimate the expected move, and for those stocks, this strategy might have an edge (assuming proper position sizing). But NFLX is one of the worst stocks to use for this strategy, considering its earnings history.
       
      Watch the video:
       
       
      If you want to learn how to trade earnings the right way (we just booked 30% gain in NFLX pre-earnings trade):
       
      Start Your Free Trial
    • By Michael C. Thomsett
      For some traders, this makes little sense. Options traders tend to be pure technical traders, concerned with implied volatility and short-term valuation of options (often ignoring how stock price behavior changes over time). This overlooks the importance of historical volatility and, equally important, of fundamental volatility as well.

      Fundamental volatility is the degree of reliability in fundamental trends. Items such as revenue, gross profit, net profit and net return are of little interest to many options traders but starting there is a good suggestion. How does a trader pick one or another stock for options activity? Ask several options traders and you discover that some (if not most) have never given this much thought. This should be surprising, but the culture of the options industry tends to lack the holistic appreciation of how the company directly affects option pricing.
       
      Flaws in IV versus fundamental value
      Implied volatility is often viewed as the "holy grail" of options trading. This ironic because IV is an estimate based on the current levels of historical volatility. The advantage is, IV is current. The disadvantage is, it is an estimate and several attributes going into IV are assumptions, often without solid foundation. The concept of fundamental volatility many apply to macroeconomic factors of an industry as it affects the company, or it refers to a company's profit and loss trends and ratios. It may also describe credit risk or return on investment. When considering options trading, the great debate is usually between IV and historical volatility. When reported revenue and earnings are steady over a decade, fundamental volatility is low. This usually is also reflected in stock price (historical) volatility and, as a result, in options premium and its implied volatility -- usually but not always. In determining which companies to pick as candidates for options trading, this is a good starting point.

      Depending on a trader's risk tolerance, it could be preferable to pick a company with high or with low fundamental volatility. The higher the fundamental volatility, the higher the risks in options trading, and the higher the profit potential. Some traders like it this way, but others would prefer low fundamental volatility and its effect on options trading risk. Profitability will be lower, but the level of predictability is lower as well, so potentially devastating losses are less likely when volatility at all levels is low.

      By mathematically calculating year to year volatility (in revenue and earnings, for example) it is easy to identify levels of fundamental volatility. A company whose revenue and earnings rise steadily over 10 years is encouraging to conservative investors; this carries over to a relative degree of safety or risk in options trading as well. 
       
      Direct impacts
      Does fundamental volatility affect historical volatility? Everyone knows that prices rise and fall for many reasons. Some can be anticipated, and others cannot. However, low fundamental volatility tends to lead directly to low historical volatility. Strong and reliable profit and loss reports are associated directly with strong and growing stock prices and earnings per share.

      The correlation is not 100% predictable because other factors also are at work – competitive trends, changes in management, mergers and acquisitions, economic changes, geopolitical influences, and much more – and these also affect stock prices. However, fundamental volatility is probably a consistent influence on stock price behavior.

      A secondary direct impact is seen between historical volatility of the stock, and pricing of the option. The consistent trading stock with relatively narrow breadth of trading will develop option pricing with narrow bid/ask spread and with a tendency to reflect lower than average implied volatility. This all represents lower than average risk. When the opposite occurs – higher or erratic breadth of trading and unpredictable, sudden price reversals – options are richer due to higher implied volatility. Options traders are aware of this and often view the situation as an opportunity foe higher profits. However, it also means that risks are greater.

      The measurement of fundamental volatility and its direct effect on historical volatility and option implied volatility, essentially defines levels of risk. This is seen in variations of bid/ask spread, movement in premium levels, and open interest.

      A complete study of fundamental volatility should begin with the study of revenue, earnings and net return. It can be further expanded into a study of dividend yield ands the payout ratio, P/E high and low each year, and the debt to total capitalization ratio, which tests working capital more effectively and accurately than the more popular but less reliable current ratio. Of the many fundamental trends and ratios, a small number can be used to articulate fundamental volatility. Focusing on revenue and earnings, dividend trends, annual high/low of the P/E ratio, and long-term trend of the debt to total capital ratio will reveal whether a company is a conservative or high-risk candidate for options trading. This eliminates the all too common problem faced by traders: Considering themselves conservative but making trades that are high-risk.

      In the options world, the question of risk tolerance and methods for picking appropriate strategies and making trades on appropriate issues, should provide the method for making sure risk tolerance affects how decisions are made. This is not practiced by all options traders, and that explains why timing problems arise and why losses occur as often as they do. As long as a conservative trader makes conservative choices, leaving the speculative traders to the willing speculator, the problems of poor selection can be reduced and eliminated.

      Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his websiteat Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.
       
    • By Kim
      Introduction
      The first question you need to answer is: will you hold your position through earnings, or will you close it before the announcement. 
       
      In some of my previous articles, I described few ways to trade earnings if you don't want to hold the trade through the announcement. Our favorite ways to do it are with Straddles and Calendar Spreads. Personally I don't like to hold those trades through earnings. But if you decide to do so, please make sure you do it the proper way and understand the risks.

      So if you decided to hold, the next questions would be: directional or non directional? Buy premium or sell premium?

      Here is a simple way to look at potential trades. The options market will always tell you how much stock movement the options market is pricing in for earnings, or any event. 
       
      For example, let’s take a look at what the options market was expecting from Apple (AAPL), which reported earnings last month.
       
      With AAPL stock trading at 190 we need to look at the price of the straddle closest to 190. And these options need to be the calls and puts that expire the week of earnings.

      In this case, with earnings on July 31, we look for the options that expire on Friday, August 3. The calls were worth approximately $4.85, and the puts were worth $4.27 just before earnings were announced. When we combine these two values it tells us that the options market is pricing in an expected move of $9.12, or 4.8%, after earnings. This is what we call the "implied move".

      Now you need to do some homework and decide if you believe the options are overpriced (and the stock will move less than the implied move) or underpriced (and the stock will move more than the implied move).
      Buying Premium
      If you believe that the options are underpriced, you should buy premium, using a long straddle or a long strangle.

      If you buy a straddle, then the P/L is pretty much straightforward:
      If the stock moves more than the implied move after earnings, your trade will be a winner. If the stock moves less than the implied move after earnings, your trade will be a loser. Taking AAPL earnings as an example:
       
      The straddle implied $9.12 or 4.8% move. In reality the stock moved almost $12, or ~6.0%. Which means that the straddle return was over 25%.

      Strangle is a more aggressive strategy. It would usually require the stock to move more to produce a gain. But if the stock cooperates, the gains will be higher as well. In case of AAPL, doing 185/195 strange would produce over 40% gain (all prices are at the market close before and after earnings).

      Obviously if the stock did not cooperate, the strangle would lose more as well. Which makes it a higher risk higher reward trade.
       
      Selling Premium
      If you believe that the options are overderpriced, you should sell premium. You can sell premium in one of the following ways:
      Sell a (naked) straddle. This strategy is the opposite of buying a long straddle, and the results will be obviously opposite as well. If the stock moves more than expected, the trade will be a loser. If it moves less than expected, it will be a winner.
        Sell a (naked) strangle. This strategy is an opposite of buying a long strangle, and similarly, a more aggressive trade. Take the last FB earnings for example. Selling 1 SD strangle would produce a $208 credit. When the stock was down almost 20% after earnings, the trade was down a whopping $2,407, which would erase 12 months of gains (even if ALL previous trades were winners). This is why I would recommend never holding naked options positions through earnings. The risk is just too high.
        Buy an iron condor. This strategy would involve selling a strangle and limiting the risk by buying further OTM strangle. In case of a big move, your loss is at least limited. Selling options around 1 SD would produce modest gains most of the time, but average loss will typically be few times higher than average gain.
        Buy a butterfly spread. This strategy would involve selling a straddle and limiting the risk by buying a strangle. In case of a big move, your loss is at least limited, like with iron condor. This strategy has much more favorable risk/reward than iron condor, but number of losing trades will be much higher as well.
        Buy a calendar spread. This strategy would involve selling ATM put or call expiring on the week of earnings and buying ATM put or call with further expiration. The rationale is that near term short options will experience much bigger IV collapse than the long options, making the trade a winner. To me, this would probably be the best way to hold through earnings in terms of risk/reward and limiting the losses. As a rule of thumb:
      If the stock moves as expected after earnings, all strategies will be around breakeven. If the stock moves more than expected after earnings, all premium buying strategies will be winners, and all premium selling strategies will be losers. So which one is better?
      To me, any strategy that involves holding through earnings is just slightly better than 50/50 gamble (assuming you did your homework and believe that you have an edge). Earnings are completely unpredictable. Selling options around earnings have an edge on average for most stocks, but they have a much higher risk than buying options, especially if the options are uncovered. Those "one in a lifetime events" like Facebook 20% drop happen more often than you believe.

      Many options "gurus" recommend selling premium before earnings to take advantage of Implied Volatility collapse that happens after earnings. What they "forget" to mention is the fact that if the stock makes a huge move, IV collapse will not be very helpful. The trade will be a big loser regardless.
      Directional or non directional?
      So far we discussed non directional earnings trades, where you select ATM options. But those trades can be structured with directional bias as well. For example:
       
      If you were bullish before AAPL earnings and believed the stock will go higher, instead of buying the 190 straddle, you could buy the 185 straddle. This trade would be bullish, and earn more if the stock moved higher, but it would also lose more than ATM straddle if you were wrong and the stock moved down. As an alternative, you could buy an OTM calendar (for example, at $200 strike). If you were right, you would benefit twice: from the stock direction and IV collapse. But you would need to "guess" the price where you believe the stock will be trading after earnings with high level of accuracy. If you guess the direction right, but the stock makes huge move beyond the calendar strike, you can still lose money even if you were right about the direction.

      For example, the 190 (ATM) calendar would lose around 40-50% (which was expected since the stock moved more than the implied move). But the 200 (OTM) calendar would gain around 120% since the stock moved pretty close to the 200 strike, so you gained from the IV collapse AND the stock movement.
      Conclusion
      Earnings trades are high risk high reward trades if held through earnings. Anything can happen after earnings, so you should always assume 100% loss and use a proper position sizing. Traders who advocate those strategies argue that they can always control risk with position sizing, which is true.

      But the question is: if I can trade safer strategies and allocate 10% per trade, why trade those high risk strategies and allocate only 2% per trade? After all, what matters if the total portfolio return. If a trade which is closed before earnings earns 20% (with 10% allocation), it contributes 2% growth to the portfolio. To get the same portfolio return on a trade with 2% allocation, it has to earn 100%.

      Is it worth the risk and the stress? That's for you to decide.

      Related articles:
      How We Trade Straddle Option Strategy Buying Premium Prior To Earnings - Does It Work? Why We Sell Our Straddles Before Earnings Selling Strangles Prior To Earnings How We Trade Calendar Spreads Long Straddle Through Earnings Backtest
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