Earnings strangles

A

akivak

Jeff Augen describes in his book http://www.amazon.com/Volatility-Edge-Options-Trading-Strategies/dp/0132354691 the following idea:

Buy strangles on volatile stocks before earnings. The idea is to buy a strangle on stocks having a history of volatile post-earning moves few days before earnings and sell just before the earnings. IV is usually increases sharply before earnings for those stocks, and the increase should compensate the negative theta, at least partially, so even if the stock doesn’t move the trade should be around breakeven or slightly profitable, worst case the loss should be limited to 15-20%. If the stock moves, the strangle can be sold for a profit, without waiting for the last day before earnings.

Has anyone used this strategy?
 
That's a tough way to make money. IV increases for weeks before earnings. If you buy early, you have double sided decay for weeks. The later you buy, the more you pay up (higher IV).

This can be overcome the underlying moves significantly pre EA and the increasing delta of one side begins to offset delta loss on the other side as well as double sided time decay.

I used to do a lot of double sided ratio calendars for earnings. We explored the idea of buying the long legs earlier but it was hit or miss. Some worked. Some didn't. It wasn't easy or conssistent money.
 
I started testing this strategy in July. July-October produced excellent results – average return of 10-11% per trade, with average of 15-18 trades per month and winning ratio around 60%. Most of the gains came from the stock moves, sometimes IV increase also helped. The idea is that IV increase helps to keep the floor under the strangle price, in most cases offseting the negative theta and even if the stock doesn’t move, average loss is around 10-15% with rare 25-30% losses, but average gain is around 25-30% with some trades producing 50-100% gains.

However, November so far is pretty bad – about 12% average loss per trade. I’m wondering of this is a result of market conditions. The markets are in trading range for the last couple of weeks and most of the stocks didn’t move.

So I’m starting to doubt if July-Oct results have been a result of market conditions and November is being more typical.
 
Hi - I'm also a fan of Augen's books. Really great insights that few others have.

Regarding opening of the long strangle / straddles before earnings I've got relatively limited experience. Options University in their gold membership area has a tool which has backtested these trades and defined the best timing to open these types of trades based on historical returns for individual stocks. The rest of their tools weren't great, but this would be interesting to trial.

These long straddle trades pre-earnings are good because of a sensible risk-reward ratio.

I have traded quite extensively Jeff Augen's other suggestion - which is opening short strangles immediately prior to earnings and closing them immediately after the earnings announcement. With these trades I have seen very good results and what I like about them is that you can quite easily analyse these trades. Clearly as with any short strangle trade there is the potential for large losses, but careful selection with a wide margin of safety and historical analysis can help mitigate this risk.
Again, I've seen very good results with this type of trade.
If you want more info I'm happy to expound.
 
I don’t think I’m currently ready to go short. Too many huge moves lately that would cause big losses.

However, I would be interested in more details about backtesting in Options University. Are you still a member? Did you do this backtesting? How easy it is? Timing is very important for those trades. You don’t want to open too early to be exposed to theta, but also don’t want to miss the IV increase. Did you check this specific parameter?
 
Quote from akivak:

I started testing this strategy in July. July-October produced excellent results – average return of 10-11% per trade, with average of 15-18 trades per month and winning ratio around 60%. Most of the gains came from the stock moves, sometimes IV increase also helped...

However, November so far is pretty bad – about 12% average loss per trade. I’m wondering of this is a result of market conditions. The markets are in trading range for the last couple of weeks and most of the stocks didn’t move.

So I’m starting to doubt if July-Oct results have been a result of market conditions and November is being more typical.
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I think you answered your own question. A long strangle is a directional strategy and if the UL's are moving, strangles do better. The movement is the main course... IV increase is the gravy.
 
Quote from akivak:

Any feedback here or on SA would be appreciated.
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My feedback would be: You're indoors, so lose the sunglasses unless needed for medical reasons. Looking like a buffoon detracts from your excellent content.
 
I think that it's a well written article describing your utilization of long strangles for earnings releases.

I think that most posters here understand the lingo but if you're going to write one or more articles on this topic or other option topics, it might be helpful to some to have a link to a page with brief definitions/explanations of option terminology, eg. implied volatility, delta, negative theta, etc..
 
Couple questions for you to think about:

(a) Do you want to hedge your gamma/decay by selling some index vol?

(b) don't you think that some of that earnings volatility would actually be priced in?
 
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