Another option trading strategy

[ggelitetrader000]

Uhm.. 15% move means 22 dollar move... so at most your straddle will be 22, bought for 15 so 7 profit.. that's $700 profit... position value at $2200, don't know where you got the 3-4k from?

You're about right on the rest.

What you need to do is estimate the IV drop following earnings. Because that will be the loss on your position.

In your case:

IV 2 days expire = 170 ($15 straddle)
IV 15 days expire = 85 ($20 straddle)

The difference between the vols gives you an estimation of what the vol will be between the two expiration dates (forward Vols), which is about 62. So your 15 day expiry IV will drop to 62, probably under... The front IV will likely drop to even lower.

This way you can estimate your loss and know what your break evens are after IV crush.

yes there might be some inaccuracy but just here to show an idea. The 700$ gain is 46% which effectively leave in the dust most of the index fund, bond and nasdaq in general .

 

[Kim Klaiman]

yes there might be some inaccuracy but just here to show an idea. The 700$ gain is 46% which effectively leave in the dust most of the index fund, bond and nasdaq in general .

Are you comparing a gain from one position to gains in the index?? To do that, it means you had to place your whole account into that single position. What if the stock didn't move? Were you willing to lose 50-80% of your account value?

 

[ggelitetrader000]

I stopped reading as soon as you failed to mention implied volatility in buying a straddle. if you don't know what implied volatility is, its run up to earnings and collapse afterwards then stop trading and start reading.

yeah looks like i could use some education on that.

 

[ggelitetrader000]

Looked briefly, seems to be closely assoc-d with the option pricing model which i have struggled in the past. http://www.investopedia.com/terms/i/iv.asp
Will look up again, thanks for inputs except for few noises.

 

[ggelitetrader000]

Trading options on stocks requires knowing how to pick stocks or predict their volatility. Once you have demonstrated an ability to do one or both of those things, you can light a fire under it with the options. Being able to use options does not make up for being unable to select stocks or predict the direction of volatility. I don't think there is anything inherent about any strategy that is wholly right or wrong. It's more a matter of checking market conditions, having preordained rules, and following them.

Based on the IV, options are mostly fairly priced. That is, if you believe the underlying IV, options generally don't have a much of a positive (or negative) expectation. Options may have a positive expectation in your hands if you know something that tells you the IV is wrong or the price is likely to change in a specific direction.

You need not be a guru at this; all you have to do is be better than average and use consistent money management. Even identifying market conditions that indicate you should *not* trade a specific strategy may provides you with an edge by lessening the volatility of your returns. For example, I did a backtest on spreads on RUT over 30 years. The expected return is approximately zero if you take every trade without considering market conditions. However, if you simply avoid trading during certain negative general market conditions, you can make money. It requires the patience to sit on the sidelines for many months at times. You'll miss some of the best trades this way, but you'll miss the worst ones, too.

I follow several dozen stocks for the industry I work in as well as free other industry I keel an eye on to reduce the gambling effect. So I tend to get a better shot than pure random pick up. Keeping track of what is happening with the each underlying companies is challenging but I think worth the effort.

 

[Kim Klaiman]

I follow several dozen stocks for the industry I work in as well as free other industry I keel an eye on to reduce the gambling effect. So I tend to get a better shot than pure random pick up. Keeping track of what is happening with the each underlying companies is challenging but I think worth the effort.

No matter how much you know (or think you know) about the stock or the industry - market reaction to earnings is unpredictable. If you trade any strategy and intend to hold through earnings, make sure you have a very good understanding of how IV works. And make sure you have some kind of edge. For example, if you buy a straddle, make sure that this specific stock has history of moving more than expected after earnings. There are tools that can help you to find out.

And the most important thing: when holding through earnings, the only risk management tool is position sizing.

You are welcome..

 

[ggelitetrader000]

The only way you can control your risk is to sell before earnings on a stock you think will move alot and have a significant build in vol going into earnings

this is completely opposite of what i'd do.

 

[misterkel]

We implement similar strategy but always sell before earnings. The straddle will make money from IV increase or gamma (stock move), sometimes from both.

Yeah - I've tried this strat. I really like it. It seems to work, but I haven't done it enough. I've also had a big loss when they changed the earnings date and vol collapsed. I used GOOG.
Do you have large-scale backtest stats to back it up as a workable strat? Wouldn't strangs be better, since gamma starts moving faster with wings?
Also - what criteria for picking stocks do you have for this strategy? Can you recommend a list of stocks that usually behave?
Thanks, Kim - it's good to see a thoughtful commentator.

 

[Kim Klaiman]

Yeah - I've tried this strat. It seems to work, but I haven't done it enough. I've also had a big loss when they changed the earnings date and vol collapsed.
Do you have stats to back it up as a workable strat? Wouldn't strangs be better, since gamma starts moving faster with wings?

Do I have stats? Yes - our 6 years track record. Straddles are among our bread and butter strategies.

Change in earnings dates (or pre-announcement) are among the major risks of this strategy. pre-announcement can actually work in your favor because in many cases it causes the stock to move. Change in earnings date is very rare (assuming the date was previously on the company website and you did not reply on third party sources).

Strangles can work as well, but they are more risky. If the stock doesn't move, they will lose more percentage wise.

More details: Straddle, Strangle Or Reverse Iron Condor (RIC)?

 

[misterkel]

Nice reply, Kim. Thanks.

You said on your TastyTrade critique that certain companies were the worst.
Any tickers you especially recommend for the strategy?