There are few parameters to this strategy, and I'm not sure what was the intention in the original email.
First question: is your intention to buy and hold through earnings?
If this is the case, I believe over time, this is a losing strategy. You might have few occasional big winners, but on average, you will lose money. The reason is simple: on average, options are overpriced before earnings, and on average, the actual move is less then the implied move, and IV collapse will make the straddle a loser after earnings.
Kirk from OptionAlpha did some backtesting on some popular stocks, here are the results:
Long Straddle Through Earnings Backtest
So you might ask: if buying straddles and holding through earnings is a losing strategy, why not to sell them? Well, this strategy should be a winner over a long term, but be prepared for few big losers down the road (FB, NFLX and TWTR are the latest examples).
So the next step would be to examine the strategy of buying a straddle few days or weeks before earnings and selling before earnings.
Here you have few 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.
Overall, this is a very low risk strategy, but you really need to know which stocks to buy, when and how much to pay. Backtesting is everything.
More details about how we use this strategy:
How We Trade Straddle Option Strategy
First question: is your intention to buy and hold through earnings?
If this is the case, I believe over time, this is a losing strategy. You might have few occasional big winners, but on average, you will lose money. The reason is simple: on average, options are overpriced before earnings, and on average, the actual move is less then the implied move, and IV collapse will make the straddle a loser after earnings.
Kirk from OptionAlpha did some backtesting on some popular stocks, here are the results:
Long Straddle Through Earnings Backtest
So you might ask: if buying straddles and holding through earnings is a losing strategy, why not to sell them? Well, this strategy should be a winner over a long term, but be prepared for few big losers down the road (FB, NFLX and TWTR are the latest examples).
So the next step would be to examine the strategy of buying a straddle few days or weeks before earnings and selling before earnings.
Here you have few 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.
Overall, this is a very low risk strategy, but you really need to know which stocks to buy, when and how much to pay. Backtesting is everything.
More details about how we use this strategy:
How We Trade Straddle Option Strategy