Earnings Volatility Plays

[spindr0]

If there's no Chicken Little market like last year, IV ranges will moderate. Oh wait, the sky DID fall in last year. Nebbermind...

You can still guesstimate post IV levels but you just have one less data refererence available. You can look at how much IV expands and how much horizontal skew increases. Either way, the results depend on how good the set up is and how well you guess

FWIW, if you're going to play with mutli-leg positions, if there are multiple ways to enter, set up combo orders for both. You can often get a better fill if someone is hell bent on getting a position. For example, a pair of calendars can also be set up as a pair of straddes or a pair of strangles, depending on the strike(s).

 

[dd4nyc]

This is not a holy grail by any means, but at any point in time one can calculate implied earnings jump, and implied post-earnings volatility. Once you have these 2 components you can either take a view on one or the other, or structure a directional/vol play. Also, you can figure out the dynamics of implied vols, like how high IV will rise, how much it will fall, what's the max spread between 2 months IV. So there's definitely a lot of different things you can do with vol over earnings cycle.

 

[spindr0]

And one other thing I forgot to mention ...

Another consideration is looking at the IV of the respective months. As you go further out, the IV effect is much less. As a loose rule of thumb, the 3rd month is usually a better indicator of where post EA IV for the 2nd month is going to head toward. And if there's a serious difference b/t the historical and the IV spectrum of the current chains, I'd go with the chains because they're reeflective of current expectations.

 

[maninjapan]

Spindr0, thanks Ill definately look at that. In the RIMM earnings thread you commented in, you meantioned unbalanced calendars, is this referring to changing the contract size between puts and calls, factoring in an opinion on which direction it is likely to move in?

 

[spindr0]

Quote from maninjapan:

Spindr0, thanks Ill definately look at that. In the RIMM earnings thread you commented in, you meantioned unbalanced calendars, is this referring to changing the contract size between puts and calls, factoring in an opinion on which direction it is likely to move in?

Yes and no.

You can tailor the risk graph (bias) to whatever outlook you foresee (hope for).

I have no clue how much or in what direction a stock is going to move post EA so I'm looking to set up something that has a balanced and favorable risk graph. With equal numbers of contracts, these strategies start out unbalanced (higher breakeven or larger risk on one side). By adding more longs or selling more shorts, you can balance the risk graph via an uneven number of contracts.

If there are peaks and troughs, you need to know approx. where they are. If the underlying moves post EA to a peak, lock it in. If during regular hours, options. If pre/post market, use stock.

There are a lot of moving parts to these and it's not a bad idea to run a number of them on a simulator to see how you and they behave.

 

[maninjapan]

A lot of this talk seems to be of taking a trade through EA, how about just going for the IV ramp and cutting it off short of the EA, does anyone have any thoughts on that?

 

[spindr0]

Quote from maninjapan:

A lot of this talk seems to be of taking a trade through EA, how about just going for the IV ramp and cutting it off short of the EA, does anyone have any thoughts on that?

That happens too. Once in awhile you see a run up peak 1-2 days before the EA.

 

[pengw]

Well, we have been playing stock earning using options for several years now.

We usually initiate a Calendar spread just before a company's earning release, around 3:45 to isolate any non earning related factors such as market move.

The strategy we use often is Calendar ratio backspread.

To find the proper ratio and to evaluate the P/L affected by the IV changes from two legs before and after ER, we use The Options Lab at http://www.TheOptionsLab.com.

The field you need use is called IV Ratio, see attached image.

By default the IV ratio is 3, what it means is, change of IV in the back month is only 1/3 of change of IV in the near month.

For example, Before ER, IV is 90% for Sep options and 60% for Oct options, if IV ratio is set to 3, then after ER, if Sep IV drops from 90% to 60%, then IV for Oct will drop from 60% to 50%.

Predicting how much IV will drop after ER is an arts. Based on our 200+ ER trades, ratio 3 is a conservative, ratio 10 is too optimistic.


( With Calendar ratio backspread, you are shorting the front month, so the bigger the drop, the better and the front month IV always drops more than the back month IVs )

 

[maninjapan]

Quote from spindr0:

That happens too. Once in awhile you see a run up peak 1-2 days before the EA.

Which would be the more common trade though, going long IV a couple of weeks leading upto EA and closing out jsut before?
Or getting on short IV just before EA and closing out just after the announcement?

I was thinking that calendar ratios meant setting the ratios to be Vega neutral, is this not the case??

 

[maninjapan]

Quote from pengw:

Well, we have been playing stock earning using options for several years now.

We usually initiate a Calendar spread just before a company's earning release, around 3:45 to isolate any non earning related factors such as market move.

The strategy we use often is Calendar ratio backspread.

To find the proper ratio and to evaluate the P/L affected by the IV changes from two legs before and after ER, we use The Options Lab at http://www.TheOptionsLab.com.

The field you need use is called IV Ratio, see attached image.

By default the IV ratio is 3, what it means is, change of IV in the back month is only 1/3 of change of IV in the near month.

For example, Before ER, IV is 90% for Sep options and 60% for Oct options, if IV ratio is set to 3, then after ER, if Sep IV drops from 90% to 60%, then IV for Oct will drop from 60% to 50%.

Predicting how much IV will drop after ER is an arts. Based on our 200+ ER trades, ratio 3 is a conservative, ratio 10 is too optimistic.


( With Calendar ratio backspread, you are shorting the front month, so the bigger the drop, the better and the front month IV always drops more than the back month IVs )

peng, thanks for the post, the strategy you refer to, a calendar ratio backspread, does that refer to having the larger number of contracts on the far month?