Earnings Volatility Plays

[maninjapan]

Quote from spindr0:

Just so we're on the same page, I have used simultaneous ratioed CRB's for earnings plays. I see them referred to as double diagonals and calendar stangles/straddles. I don't care what you call them as long as we're talking about the same beast.

They can be standard (sell near month) or reversed (sell further month). Generally, the standard ones involved buying more long legs and the reversed positions generally involve selling more short legs. And they're usually unbalanced in order to achieve a desired risk profile.

The process involves several components. Near term IV has to be inflated. There has to be horizontal skew (I prefer more than 15 basis pts). A historical pattern of IV contraction is nice but as IV_Trader mentioned and previously discussed, it's of no use now due to last year's market fall and wild IV inflation.

You can just look at the big names (ala AAPL, ISRG, GOOG, etc.). A more comprehensive screening of the list of upcoming EA's takes a lot of leg work... or mouse work. Unless you have access to sophisticated database (fee?) or are adept at programming, it helps if you work in collaboration with someone else.

As to your question, how do you determine the ratio? I plug the strategy into my 2 bit modeling program and graph the position. Perhaps start with a 10/-10/-10/10 position. If it meets certain criteria, it goes forward. Increasing the number of long or short legs alters the risk profile (see bebpasco's RIMM trade). When you find an acceptable one, you're good to go. Then it's only a question of trying to get a better fill via combo orders or legging in.

At some point you're going to have grind out some of these on paper or in a simulator. All the talk in the world isn't going to give you real world insight into how these perform or whether they're suited for your trading. It's a time consuming process to evolve trading strategies and this is certainly one of them.

Spindr, one more question (promise Ill go away and wont come back till Ive done more modelling) you mentioned that you like to see an inflated skew of at least 15 points. Are you referring to your requirements for a calendar or reverse calender here?

 

[spindr0]

Quote from maninjapan:

Spindr, one more question (promise Ill go away and wont come back till Ive done more modelling) you mentioned that you like to see an inflated skew of at least 15 points. Are you referring to your requirements for a calendar or reverse calender here?

No need to stop asking questions or go away.

My apologies for not being more specific. We've been knocking several things around and they've sort of run together at times. The 15 BP's of IV is for pairing the backspreads not for double reverse calendars (with one and a half turns

 

[spindr0]

Quote from bebpasco:

So Born is IV Trader? I wonder who else is here from the old Yahoo board under a different ID? lolol!

I thought about his IV expansion trade strategy last year as IV was going thru the roof. At first, I thought he making a fortune --- and probably still did. But it must have been a slippage nightmare adjusting those positions back to delta neutral.

Yep, that be true except that he's no longer offering rope to one specific poster

For me, last year was a bonus year for outright trading. None of that IV related wussy stuff

 

[ramaTrade]

Quote from maninjapan:

peng, a ratio of 3, is that in regards to your position size? 3 on the front month to 1 on the back month?

The previous post mentioned ratio 3 means after ER, front month IV drop 3 times as much as back month IV. i.e. if before ER, IV is 90% and 60%, after ER, IVs will be 60% and 50% if ratio is set to 3.

 

[IV_Trader]

Quote from 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.

Do you mind to predict future vola levels here (any stock will do)?
Front month pre-after report and calendar tenor

 

[bebpasco]

Quote from spindr0:

Yep, that be true except that he's no longer offering rope to one specific poster

For me, last year was a bonus year for outright trading. None of that IV related wussy stuff

lol! Some how I think that "specific poster" will survive.

Congrats on 2008. Nothing special for me last year. But, 2009 so far ---- whoa baby!

 

[dd4nyc]

Let's say you're looking at BBBY. Implied vols in my software are
Sep 34.9% (7 trading days)
Oct 40.7% (27 trading days)
Nov 38.1% (52 trading days)

Using excel you can calculate that market expects 7.25% volatility jump on earnings, and non-earnings vol of 2.2%, or 34.8% annualized.

Looking at the last 3 earnings for BBBY I see that historical earnings moves (close to close) were 9% (june), 21.7% (apr), 4.5% (jan), average of 13.9%.

So, market expects earnings jump for BBBY to be lower than recent earnings jumps.

Furthermore, if you extend these numbers father out, you can forecast that october implied volatility will continue to rise until the earnings date (sep 23 , in 2 weeks ) reaching the high of 43.3%, and november vol will rise to 39.6%. After earnings both implied vols will collapse to 34.8%.

This above will of course depends on the overall vol staying the same, which never happens, but I wanted to give some hard numbers instead of handwaving.

In parallel with pengw's analysis, oct vol will drop by 8.5% and nov vol will drop by 3.8% with ratio of 2.24, which is close to his (universal) ratio of 3.

 

[IV_Trader]

Quote from dd4nyc:

Let's say you're looking at BBBY. Implied vols in my software are
Sep 34.9% (7 trading days)
Oct 40.7% (27 trading days)
Nov 38.1% (52 trading days)

Using excel you can calculate that market expects 7.25% volatility jump on earnings, and non-earnings vol of 2.2%, or 34.8% annualized.

Looking at the last 3 earnings for BBBY I see that historical earnings moves (close to close) were 9% (june), 21.7% (apr), 4.5% (jan), average of 13.9%.

So, market expects earnings jump for BBBY to be lower than recent earnings jumps.

Furthermore, if you extend these numbers father out, you can forecast that october implied volatility will continue to rise until the earnings date (sep 23 , in 2 weeks ) reaching the high of 43.3%, and november vol will rise to 39.6%. After earnings both implied vols will collapse to 34.8%.

This above will of course depends on the overall vol staying the same, which never happens, but I wanted to give some hard numbers instead of handwaving.

In parallel with pengw's analysis, oct vol will drop by 8.5% and nov vol will drop by 3.8% with ratio of 2.24, which is close to his (universal) ratio of 3.

DD , I appreciate direct and non BS answer, thanks
I personally don’t agree but if it works for you that what counts

 

[maninjapan]

Quote from maninjapan:

Spindr, one more question (promise Ill go away and wont come back till Ive done more modelling) you mentioned that you like to see an inflated skew of at least 15 points. Are you referring to your requirements for a calendar or reverse calender here?

Spindr0, I was reviewing your earlier post on CRB's and you said yousaid candidates needed a minimum IV gap of 15 points.
So this would mean your selling near months and buying more far out months(higher strike), correct? this gives you a positive Vega position. I would have thought if you are betting on a close of the gap and a general decrease in the IV you would be heavy on the near options. What is the line of thinking with that? Ive gone back and tried it on a few previous EA's but yet to find th eright conditions for it. Any specific EA's that worked that come to mind?

 

[spindr0]

1) you said candidates needed a minimum IV gap of 15 points

5 BP's needed to evaluate a position NOT do it


2) So this would mean your selling near months and buying more far out months(higher strike), correct? this gives you a positive Vega position. I would have thought if you are betting on a close of the gap and a general decrease in the IV you would be heavy on the near options. What is the line of thinking with that?

If your belief is that the underlying isn't going to move, go heavy on the near term options.


3) Ive gone back and tried it on a few previous EA's but yet to find th eright conditions for it. Any specific EA's that worked that come to mind?

Here's a hypothetical for you.
Consider a calendar strangle.
Stock at 52
Price a near month 50/55 at .65
Price a 2nd month at .50
Overnight post EA expectation is .45 (pretend both will go there)

What would be a ratio of contracts bot/sold that would balance the maximum loss in either direction? Then, would the risk graph have an acceptable risk/reward ratio?

Do the same evaluation for diagonals.

These types of positions may not be for you but until you start modeling them, you won't know and all the word descriptions in the world will be meaningless.