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Found 8 results

  1. Kim

    Studies Vs. Real Trading

    tastytrade tried to Put The Nail In The Coffin On Buying Premium Prior To Earnings. They did it several times, and we debunked their studies several times. Kirk Du Plessis from OptionAlpha conducted a comprehensive study backtesting different earnings strategies. This is the part that is relevant to our pre earnings straddle strategy: The conclusion is that buying long straddle (or strangle) and closing the day before earnings is a losing proposition. The backtest included different entry days from earnings: 30, 20, 10, 5, or 1 day from the earnings event. Our real life trading results are very different: You can see full statistics here. 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
  2. How straddles make or lose money A long straddle option strategy is vega positive, gamma positive and theta negative trade. It works based on the premise that both call and put options have unlimited profit potential but limited loss. If nothing changes and the stock is stable, the straddle option will lose money every day due to the time decay, and the loss will accelerate as we get closer to expiration. For the straddle option strategy to make money, one of the two things (or both) has to happen: 1. The stock has to move (no matter which direction). 2. The IV (Implied Volatility) has to increase. While one leg of the straddle losses up to its limit, the other leg continues to gain as long as the underlying stock rises, resulting in an overall profit. When the stock moves, one of the options will gain value faster than the other option will lose, so the overall trade will make money. If this happens, the trade can be close before expiration for a profit. In many cases IV increase can also produce nice gains since both options will increase in value as a result from increased IV. This is how the P/L chart looks like for the straddle option strategy: When to use a straddle option strategy Straddle option is a good strategy if you believe that a stock's price will move significantly, but don't want to bet on direction. Another case is if you believe that IV of the options will increase - for example, before a significant event like earnings. I explained the latter strategy in my Seeking Alpha article Exploiting Earnings Associated Rising Volatility. IV 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. This is one of my favorite strategies that we use in our SteadyOptions model portfolio. Many traders like to buy straddles before earnings and hold them through earnings hoping for a big move. While it can work sometimes, personally I Dislike Holding Straddles Through Earnings. The reason is that 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. Selection of strikes and expiration I would like to start the trade as delta neutral as possible. That usually happens when the stock trades close to the strike. If the stock starts to move from the strike, I will usually roll the trade to stay delta neutral. Rolling simply helps us to stay delta neutral. In case you did not roll and the stock continues moving in the same direction, you can actually have higher gains. But if the stock reverses, you will be in better position if you rolled. I usually select expiration at least two weeks from the earnings, to reduce the negative theta. The further the expiration, the more conservative the trade is. Going with closer expiration increases both the risk (negative theta) and the reward (positive gamma). If you expect the stock to move, going with closer expiration might be a better trade. Higher positive gamma means higher gains if the stock moves. But if it doesn't, you will need bigger IV spike to offset the negative theta. In a low IV environment, further expiration tends to produce better results. Straddles can be a cheap black swan insurance We like to trade pre-earnings straddles/strangles in our SteadyOptions portfolio for several reasons. First, the risk/reward is very appealing. There are three possible scenarios: Scenario 1: The IV increase is not enough to offset the negative theta and the stock doesn't move. In this case the trade will probably be a small loser. However, since the theta will be at least partially offset by the rising IV, the loss is likely to be in the 7-10% range. It is very unlikely to lose more than 10-15% on those trades if held 2-5 days. Scenario 2: The IV increase offsets the negative theta and the stock doesn't move. In this case, depending on the size of the IV increase, the gains are likely to be in the 5-20% range. In some rare cases, the IV increase will be dramatic enough to produce 30-40% gains. Scenario 3: The IV goes up followed by the stock movement. This is where the strategy really shines. It could bring few very significant winners. For example, when Google moved 7% in the first few day of July 2011, a strangle produced a 178% gain. In the same cycle, Apple's 3% move was enough to produce a 102% gain. In August 2011 when VIX jumped from 20 to 45 in a few days, I had the DIS strangle and few other trades doubled in a matter of two days. The main risk to this strategy is earnings pre-announcements. They can cause volatility crash and significant losses. To demonstrate the third scenario, take a look on SO trades in August 2011: To be clear, those returns 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. Overall this strategy produces over 75% winning ratio with very low risk. It is very rare to lose more than 10-15% using pre earnings straddle strategy. Summary A long straddle option can be a good strategy under certain circumstances. However, be aware that if nothing happens in term of stock movement or IV change, the straddle will bleed money as you approach expiration. It should be used carefully, but when used correctly, it can be very profitable, without guessing the direction. If you want to learn more about the straddle option strategy and other options strategies that we implement for our SteadyOptions portfolio, sign up for our free trial. The following Webinar discusses different aspects of trading straddles. Related Articles: 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 Is 5% A Good Return For Options Trades? Want to learn more? We discuss all our trades on our forum. Start Your Free Trial
  3. We already debunked some of those "studies" here and here. Today we will debunk another study, and will show how to do it properly. On July 7, 2015, tastytrade conducted a study using AAPL, GMCR, AMZN and TSLA. An ATM straddle was purchased 21 days prior to earnings and closed the day before earnings. A table showed the results. The win rate, total P/L, average P/L per day, biggest win and biggest loss were shown: Their conclusion: Wait... They concluded that buying volatility prior to earnings doesn't work based on 4 stocks? Why those 4 specific stocks? Why 21 days prior to earnings? Our members know that those 4 stocks are among the worst to use for this strategy. They also know that entering 21 days prior to earnings is usually way too early (there are some exceptions). Also, what is a significance of dollar P/L when comparing stocks like AMZN and AAPL? At current prices, AMZN straddle would cost around $8,500 while AAPL straddle around $1,200. Theoretically, if we had a 10% loss on AMZN (-$850) and 50% gain on AAPL ($600), the total P/L would be -$250. But the correct calculation would be total P/L of +40% because we need to give equal dollar weight to all trades. But lets see how changing just one parameter can change the results dramatically. We will be using AAPL as an example. First lets use the study parameter of 21 days. Tap Here to See the back-test Entering 21 days prior to earnings is indeed a losing proposition. But lets change it to 10 days and see what happens: Tap Here to See the back-test Can you see how changing one single parameter changes the results dramatically? I have a feeling that tastytrade knew that 21 days would be not the best time to enter - but using different parameters wouldn't fit their thesis. Now lets test the strategy on some of our favorite stocks. NKE, 14 days and 15% profit target: Tap Here to See the back-test MSFT, 7 days and 15% profit target: Tap Here to See the back-test CSCO, 21 days and 10% profit target: Tap Here to See the back-test IBM, 7 days and 15% profit target: Tap Here to See the back-test ORCL, 14 days and 20% profit target: Tap Here to See the back-test WMT, 7 days and 10% profit target: Tap Here to See the back-test As you can see, different stocks require different timing and different profit targets. Some work better entering 7 days prior to earnings, some might improve performance with an entry as early as 21 days prior to earnings. The bottom line is: you cannot just select random stocks, combine it with random timing and no trade management, and declare that the strategy doesn't work. But if you select the stocks carefully, combine it with the right timing and trade management, it works very well. Here are our results, based on live trades, not skewed "studies": 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? Why We Sell Our Straddles Before Earnings Is 5% A Good Return For Options Trades?
  4. In this article, I will show why it might be not a good idea to keep those options straddles through earnings. As a reminder, a straddle involves buying calls and puts on the same stock with same strikes and expiration. Buying calls and puts with the different strikes is called a strangle. Strangles usually provide better leverage in case the stock moves significantly. Under normal conditions, a straddle/strangle trade requires a big and quick move in the underlying. If the move doesn’t happen, the negative theta will kill the trade. In case of the pre-earnings strangle, the negative theta is neutralized, at least partially, by increasing IV. The problem is you are not the only one knowing that earnings are coming. Everyone knows that some stocks move a lot after earnings, and everyone bids those options. Following the laws of supply and demand, those options become very expensive before earnings. The IV (Implied Volatility) jumps to the roof. The next day the IV crashes to the normal levels and the options trade much cheaper. 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 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. Start Your Free Trial
  5. First of all, as a general comment, there is no such thing as guaranteed returns in the stock market. If there was, everyone who is trading the stock market would be a millionaire. The proposed trade is called a straddle option. A straddle option strategy is vega positive, gamma positive and theta negative trade. That means that all other factors equal, the option straddle will lose money every day due to the time decay, and the loss will accelerate as we get closer to expiration. For the straddle to make money, one of the two things (or both) has to happen: 1. The stock has to move (no matter which direction). 2. The IV (Implied Volatility) has to increase. In simple terms, Implied Volatility is the amount of stock price fluctuations. Being on the right side of implied volatility changes can enhance the chances of success. The problem with the proposed setup is that you are not the only one who knows about the event - it’s a public knowledge, so market participants bid the options prices in anticipation of the event, driving IV to higher than usual levels. After the event the IV usually collapses. If the stock moves more than “implied” by the straddle price, then the straddle will be a winner. BUT more often than not, the options prices overprice the potential move, and when the stock moves less than expected, collapsed IV will make the straddle a loser. Example: NFLX was scheduled to report earnings on October 15, 2015. The stock was trading around $110, and 110 straddle around 15.50. This price "implied" $15.50 move. The following image presents the P/L chart of the trade: As we can see, the IV is around 240% for those options, reflecting the upcoming event. Fast forward 24 hours: the stock moved $9 which is a substantial move, but less than "implied" by the options prices. This is the P/L chart: As we can see, IV collapsed to ~85%, and the trade has lost 42%. At SteadyOptions, we trade straddles in a different way. We usually buy a straddle around 7-10 days before the event and sell it 1-2 days before the event when IV peaks. This setup can benefit from the stock moving and/or IV increase. Related articles: How We Trade Straddle Option Strategy Buying Premium Prior to Earnings Can We Profit From Volatility Expansion into Earnings Understanding Implied Volatility How We Made 23% On $QIHU Straddle In 4 Hours Want to learn more? Start Your Free Trial
  6. 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? Why We Sell Our Straddles Before Earnings Long Straddle: A Guaranteed Win? How We Made 23% On QIHU Straddle In 4 Hours
  7. Kim

    Straddle Option Overview

    The following infographic gives a brief introduction of a straddle option strategy.
  8. Mark Wolfinger

    Selling Straddles: Too Risky?

    The truth is that selling straddles is a strategy that seeks a high profit and it must come with significant risk. When you are naked short options, loss is theoretically unlimited – and there's nothing to be done about that. Sure, we know there will not be a 50% one-day rally, nor will there be a one-day 75% decline. But they are theoretically possible and that makes it impossible to estimate the maximum loss for the straddle. If willing to live with the risk of a gigantic loss, then you may be comfortable selling straddles. However, because you are asking about risk reduction, I assume that unlimited loss is something you prefer to avoid. Iron Condor vs. Straddle The best (in my opinion) protection is to buy a put that is farther OTM than your short put. In other words, I am willing to pay that very high price for the put because it provides complete protection against a huge gap opening – or any significant move. By 'complete protection' I mean it establishes a maximum possible loss. When you have the ability to set that loss potential, you are in position to trade more effectively. Money management For example, when you recognize the worst possible result, you are better able to size the trade properly. Translation: You can make a very good judgement about how many contracts to trade. When selling straddles, there is no good method to allow effective money management. Note the difference: You can manage risk by adjusting positions as needed – assuming that there is no large market gap. However, there is no way to practice sound money management money when you don't have a good estimate of how much is at risk. Yes, this is very expensive, reduces potential profits significantly and converts the straddle into an iron condor (assuming you do this on both the put and call sides). However, it does allow you to have a better handle on money management and risk management. Alternative: Strangle If you fear, or anticipate a market decline, you can take out partial insurance right now – when initiating the position. There is nothing magical about selling straddles, and you can trade a strangle instead. In this scenario, you would sell the 1185 call, as planned, but could choose a lower strike put. Perhaps the 1165 or the 1150 put? The point is that you build in your market bias by making a small (not 100 points) adjustment in the strike prices of the options sold. Protection I've been trading options since 1975 and have come to one major risk management rule that suits my comfort zone. I no longer sell any naked options (unless I want to buy stock and elect to sell a naked put in an attempt to buy stock at a lower price). I have incurred too many large losses from being short far too many naked options – both calls and puts. I am NOT telling you to adopt that same limitation. What I am doing is asking you to consider the risk of selling straddles and decide if it works for you. It may be a perfect (high risk) strategy for your trading style. a) Buying debit spreads (puts in your example) is far less costly and provides far less protection than buying single options. And that protection is limited. But if there is no huge gap, this is a very useful method to reduce risk. I'd prefer not to constantly use the phrase 'if there is no gap,' but the truth is, that's the big, ugly enemy for the naked call or put seller. That gap eliminates the opportunity to make a timely adjustment before disaster occurs. b) Another risk management method to consider is to reduce the time that you own the short straddle position. True, the most rapid time decay comes near expiration, but if you take the extra risk associated with selling naked options, you can counter some of that risk by not holding into expiration. Consider owning the position for only two or three weeks, taking the profit, and waiting patiently until it's time to open a new straddle. Being out of the market is one sure method for reducing risk. c) Other solutions exist, but buying single options or debit spreads represent the most simple and effective choices. Another example is an OTM put backspread. But please be warned: The risk graph may look very good today and you may feel adequately protected today, but the passage of time turns these into situations in which you may incur a big loss from the original straddle plus another from the back spread. Example Buy some SPX Dec 1120 puts and sell fewer SPX Dec 1130 puts. Because you own extra options, the gigantic downside move will not hurt. However, if SPX declines and moves near 1120 as expiration arrives, this backspread can lose big money. This is not the appropriate time to go into a further description of the backspread, but some of the problems are mentioned in this post. Related articles Trading An Iron Condor: The Basics How To Blow Up Your Account Trader Mindsets The Options Greeks: Is It Greek To You? Want to learn how to trade options in a less risky way? Start Your Free Trial