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Kogelet

My doubts about buying straddles before earnings

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Dear community!

I would like to get an opinion about the following video. I posted the link below. 

After making some research, I made the following assumptions and conclusions. 

- Options are probability-based financial instruments. The premium paid for buying a straddle is supposed to include all risks related to the potential change of IV, theta, gamma. 
- The chances of gain are 50/50 similarly to any short time predictions of the market price. Besides, you lose the spread and pay commissions. 
- Options pricing already includes any potential increase in IV and time decay is more likely to kill the potential trade.
- As the markets are very efficient, Options pricing already includes information about historical volatility. Even if we find stocks with high historical volatility during previous earnings, the greeks are always balanced between each other to make your chances of win to 50/50 minus spreads & commissions. 

So, what you think?
 

 

As options are 

 

 

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Take a look:

 

 

I debunked tastytrade studies many times.

 

We will let them to do their studies and will continue making money with real trading, not theoretical studies. We prove the sceptics wrong every day - just look at our performance page.

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he looked at 4 earnings cycles for 5 stocks to write off a strategy?  Is he serious?  haha

 

this clip is a perfect example of everything that is wrong with tom sosnoff. 

Edited by RapperT

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Not only he selected 5 random stocks (which among the worst for this strategy) and random time to enter - but he also tested it with Future ATM straddle.

Are you getting it?? He gives an example of AAPL trading at 92, and if you knew it would be at 94 before earnings, you would buy 94 straddle. I couldn't believe it, had to watch it few times.

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1 minute ago, Kim said:

Not only he selected 5 random stocks (which among the worst for this strategy) and random time to enter - but he also tested it with Future ATM straddle.

Are you getting it?? He gives an example of AAPL trading at 92, and if you knew it would be at 94 before earnings, you would buy 94 straddle. I couldn't believe it, had to watch it few times.

supposedly his data guy has a phd...I wonder how he feels about whoring himself out to support Tom's crazy dogmatic (and usually fallacious) proclamations .  Then again most phd are meaningless these days.

I stopped watching when he cited his sample size and called people who disagree with him "monkeys" so i missed the part about the straddle prices.  That is hilarious and scary.

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13 minutes ago, Christof+ said:

"Half of our team went out, .... 'cause this requires a crap load of work" for 5 stocks and 2 years of data? Amazing.

We can be happy though, less chance that these trades get too crowded over time.

Even better they provide liquidity for the straddles we want to buy heading into earnings 

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      The study was done today - here is the link. The parameters of the study:
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      Image source: tastytrade  
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      SPY 16 Delta Strangles


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      Image source: tastytrade
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      IWM Short Straddles


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    • By Stephan Haller
      Lately we experienced a 7% down move in the S&P 500.
       

      image source: TOS trading platform  
      We have also seen an explosion in the VIX.


      image source: TOS trading platform  
      All in all a pretty shitty situation if you have a delta neutral short premium portfolio.
       
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      Set up
      As shown in my books, IWM, FXE, TLT, GLD, XLE are the most uncorrelated ETFs. With these underlyings you have exposure to the Russell 2000, the Euro Currency, Bonds, Gold and the Oil Sector.
       
      Rules
      $100k portfolio capital allocation based on the VIX (20-25% allocation in very low VIX environment, 40-50% in a high VIX environment) equal buying power in all underlyings never go above 3x leverage in notional value 30 delta short strangles or atm straddles about 45 DTE profit target = 16 delta strangle credit at trade entry close all positions at 21 DTE if profit target is not hit before if short strike in strangles gets hit, roll untested side into a short straddle (original profit target doesn't change) if break even in a short straddle gets hit, roll untested side to the new atm strike (going inverted) if IVR in IWM goes above 50% and/or VIX makes a big up move, add aggressive short delta strangle to balance deltas
        Portfolio Performance
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      IWM

      image source: TOS trading platform
        FXE

      image source: TOS trading platform  
      TLT

      image source: TOS trading platform  
      GLD

      image source: TOS trading platform  
      XLE

      image source: TOS trading platform  
      Portfolio


      So far in dollar terms a $1,571.50 loss or 1.571% loss on the whole portfolio.

      Not too bad considering the IV explosion and the big moves, especially in TLT.

      As you can see, even in a tough market with big outside the expected moves and IV explosion, short strangles/straddles are not a recipe for disaster.

      The key is to trade small when IV is low and mechanically adjust your positions/deltas.

      Of course the expiration cycle is not over yet and we can still have more big moves and much higher implied volatility in the coming days, but you should have seen now, when you have the right set of rules and religiously stick to these rules and when you trade small enough when IV is low, you are not going to blow up your portfolio.

      Stephan Haller is an author, teacher, options trader and public speaker with over 20 years of experience in the financial markets. Check out his trilogy on options trading here. This article is used here with permission and originally appeared here.



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    • By Kim
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      While we use this strategy on a regular basis, it is not among our most profitable strategies. During periods of low volatility, it usually produces 3-5% return per trade (including the losers). To put things in perspective, even 3% return is not that bad. The average holding period of those trades is around 5 days, so 3% return translates to 219% annual return. If you traded 40 straddles per year and allocated 10% per trade, those trades alone would contribute 12% to your account. Considering the low risk (the straddles rarely lose more than 7-10%), this is a pretty good return.
       
      But this is where it really gets interesting: I consider those trades a cheap black swan protection. If IV goes up sharply followed by the stock movement, this is where the strategy really shines. It can provide a really good protection to your options portfolio in case of sharp moves.
       
      Examples
       
      Lets take a look on few real life examples of trades that benefited from market volatility.
      Entered HPQ strangle on August 3, 2011, exited on August 8, 2011 for 109.7% gain. Entered DIS strangle on August 3, 2011, exited on August 8, 2011 for 107.1% gain. Entered CRM strangle on August 3, 2011, exited on August 8, 2011 for 101.7% gain. Entered AKAM straddle on July 23, 2012, exited on July 26, 2012 for 38.9% gain. Entered FNSR straddle on March 6, 2013, exited on March 7, 2013 for 24.2% gain. Entered MSFT straddle on June 24, 2014, exited on July 17, 2012 for 35.4% gain. Entered QIHU straddle on August 19, 2015, exited on August 19, 2015 for 22.9% gain. To be clear, the returns from 2011 can probably happen once in a few years when the markets really crash. But if you happen to hold few straddles or strangles during those periods, you will be very happy you did.
       
      Summary
       
      To be successful with this strategy, you need to know what you are doing. Not every stock works equally well. There are many moving parts to this strategy:
      When to enter? Which stocks to use? How to manage the position? When to take profits? If used properly, the pre-earnings straddles can provide decent gains during periods of low to medium volatility. But at the same time, they can provide excellent black swan protection. Are you familiar with another way to get black swan protection that costs you nothing - in fact, it even produces some gains? I'm not.
       
      Related Articles:
      How We Trade Straddle Option Strategy
      Buying Premium Prior to Earnings
      Can We Profit From Volatility Expansion into Earnings
       
      Want to learn more?
       
      Join SteadyOptions Now!
    • 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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      How We Made 23% On QIHU Straddle In 4 Hours
    • By Kim
      First, a reminder:
       
      Straddle construction:
      Buy 1 ATM Call
      Buy 1 ATM Put


       
      Strangle construction:
      Buy 1 OTM Call
      Buy 1 OTM Put


       
      Reverse Iron Condor construction:
      Buy 1 OTM Put
      Sell 1 OTM Put (Lower Strike)
      Buy 1 OTM Call
      Sell 1 OTM Call (Higher Strike)


       
      When buying a straddle, we are buying calls and puts with the same strikes and expiration. When buying a strangle, we are buying calls and puts with different strikes. The strangle will have the largest negative theta (as percentage of the trade value, not absolute dollars). Further you go OTM, the bigger the negative theta. If the stock moves, the strangle will benefit the most. If it doesn't it will lose the most. I found that if I have enough time before expiration, deltas in the 25-30 range provide a reasonable compromise.
       
      For lower priced stocks, I would prefer a ATM (At The Money) straddle (buying the same strikes). Strangle on a $20 stock might be very commissions consuming, plus the negative theta might be too big.
       
      Please note that when I'm talking about the theta being larger or smaller, I'm always referring to percentages, not dollar amounts. In absolute dollars, the theta is always be the largest for ATM options. However, since those options are also more expensive in dollar terms, percentage wise the theta will be the smallest.

      Generally speaking, dollar P/L is usually similar for strangles and straddles. However, since strangles are cheaper in dollar terms, percentage P/L will be higher for strangles. This applies to both winners and losers, which makes a strangle a more aggressive trade (higher percentage wins but also higher percentage losses). If the stock price moves significantly, strangles will likely produce higher returns. But if the stock doesn't move and IV increase is not enough to offset the negative theta, strangles will also lose more.
       
      For higher priced stocks (over $100) I will usually do RIC. Since you sell a further OTM strangle against the purchased strangle, this reduces the theta of the overall position. It might be the least risky position and still benefit from IV jump like AMZN trade. I prefer to have spreads of $5 for RIC.
       
      Since I don't know what will happen with the stock I play, I prefer to have a mix of all three. In case of a big move, strangles will provide the best returns. When IV is low, RIC will provide some protection against the theta while still having nice gains from time to time.
       
      Remember: those are not homerun trades. You might have a series of breakevens or small losers, but one down day can compensate for the whole month. This is why I want to be prepared when it happens. In August I had 4 doubles in two days (but I played mostly strangles).
       
      When you want to trade earnings and expect a big move, those strategies can provide excellent returns. RIC has limited profit potential, but when the stock moves less than expected, it can provide better returns than straddle or strangle with less risk.
       
      The bottom line:
       
      Strangle is the most aggressive trade, with higher risk and higher reward. It has the highest negative theta (as percentage of the trade price) so it will lose the most if the stock doesn't move and/or IV doesn't increase enough to offset the theta. 
       
      RIC is the most conservative trade. Straddle falls in the middle, and many times it provides the best risk/reward.
       
      Let me know if you have any questions.
       
      Related articles
      How We Trade Straddle Option Strategy Reverse Iron Condor Strategy Why We Sell Our Straddles Before Earnings  
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