Equity option trading

Okay, looks like a better morning than yesterday, especially with strong earnings from SOLF, which has been hot as of late, and jumping another +10%.

and for those that didn't understand what I meant by the IV issue. Let's take a look at SOLF. IV on those SOLF June 25 calls are at 110%. You can expect the IV to drop to about 60-80 once market opens. The options closed at $3.20/$3.50 yesterday. With a +13% move pre-market, the options should be at $4.20 with the new IV range of 60-80. We'll see if that holds true when the market opens.
 
And here's what I have at the open. SOLF is now at $28.30, those SOLF June 25 calls are at $4.50/$4.70 and the IV on that option is now at 80.

Just as expected, the IV dropped from its high yesterday of 110 back to an average level at 80. My option price calculations had IV at 70, so you're getting a better deal right now if you closed out your position. But as you can see, an 11% move in the stock only got you a 28% gain on your options (if you bought at the closing price of $3.50 yesterday and closed this morning at $4.50). For an earnings play, this play would not have given you a good risk ratio, in fact you'd be looking at a risk ratio under 1.

Moving on, you can still be a winner playing the directional game using options before earnings. Just make sure your research give you the edge.
 
As for this morning I added new options:

Bought 15 NTES June 25 calls at $1.45 for ($2193.75)

Still holding 7 AZO June 135 calls now at $1.95
10 CRM June 70 calls at $1.40
10 ARD June 55 calls at $4.00
10 UPL June 95 calls at $3.70

I'd hold ARD and UPL for another 1-2 days before letting go....just in case traders sell off oil on Friday heading into the Memorial Holiday weekend.
 
Well the point was not to get you to do pure vol plays like short straddles and such which are too risky, but to consider volatility and use it go directional with spreads. For example, instead of the long calls which you know will get hit with volatility crush whether stock goes up or down, use bull call spreads to reduce effect of volsbut still take a directional bias and reduce some of the risk. You might have strong headwinds with long calls expecting delta gains to overcome vega loss whereas with the spread you give up some of the deltas to flatten out to an extent the vol loss.

For the next earnings trade where vols are juiced, put a long call and bull call spread side by side or do your real long call and paper trade the bull call spread and compare how they react.

Do not get enamoured with % returns on specific position since it is distorted. If you buy a $1.50 call and it goes to 1.75 that is a nice 16% return but the returns are magnified due to leverage. See how much money you make versus what you have to risk when comparing a long call with a bull call spread.
 
I understand your point, where using a bull call spread will lower my risk, especially on these earning trades because of their increased IV. It is a good and valid point, and should be considered for new option traders/investors who are new to high IV earning trades.

But then, by putting on a bull call spread, I would be suggesting to myself that I'm not too sure if I'm correct on the move. let's take a look at a bull call spread that I just bought. Took NTES June 25/30 calls buying 10 each. The net debit was $1.00. Theoretically, if NTES closed at $30 on June 21, I would have a net gain of 300%. Not bad compared to the 284% you would have netted buying the June 25 calls outright at $1.30. The problem here is that I would be trading options based on a perfect world scenario where things fall into place at the right time.

We know reality is quite different. Here's the reality side to this theory. NTES reports tomorrow and on a surprise, I will see NTES gap to $27 and the IV on the options fall from current level of 53 back to average level of 37. Buying the June 25 calls at $1.30, I will expect the calls to move to $2.60, and catch a +100% return on my cost.

For a bull call spread, I will expect to close the long calls at $2.60 and cover the short call at $0.80 for a net of $1.80 against my cost of $1.00. The net gain here is +80%. Eroding more profit here is the fact I paid double commission for this trade.

But I have put it on for display:
In addition to the NTES calls I bought earlier, I also bought 5 NTES June 25 calls at $1.30 and sold to open 5 NTES June 30 calls at $0.30 for total cost of ($525.90)

Let's get it on.
 
A few problems:

1. You are comparing % returns in perfect scenrio to justify one over the other. Option returns are misleading when you quote 80% versus 100%. You need to look at what you are risking in terms of debit AND volatility.

2. You only present the scenerio where the stock issues a surprise and gaps up $2.00. Compare the two if stock stays sideways and vols drop or stock drops and vols drop. To be fair you cannot just pick the scenerio you hope will occur to show why the long call works better.

3. I am not trying to convince you that you should trade X or Y but volatility consideration means that sometimes the spread will work out better over the long run on losing situations due to hedging volatility exposure. With all due respect all of your comments are only looking at how much you make when the stock gaps higher on good earnings. If you truly expected that, and that scenerio was guaranteed you would be doing huge size in the long calls and leveraging all you can.

Anyway, just want to make the point on volatility and that i think you are still not seeing the benefits when you are wrong, only the cost when you are right. That is fine if you are always right but...

Good Luck.
 
Good point you just made, I am only looking at the scenario where I'm looking for a 10% move up or down, in the case of NTES and CRM, I'm looking for 10% move up. My research is soley based on that issue. Hence, these are earning trades and nothing more.

I should point out, trading earning trades here blindly, a trader only has a 33% chance of picking the correct direction with a risk ratio of 1:1, because there's a 33% chance of an up move, down move, and no move at all on the stock. Choosing up, the trade would lose if if the stock didn't move or if the stock moved down.

I started with that reality in mind. Then, I used some basic technical/fundamental/contrarian research to increased my odds from 33% to about 66% winning trades with a risk ratio of 2:1.

From the Quarter from Jan-Mar. 2008, I made 26 earning trades, 17 winners and 9 losers making 65% of my trades winners. My risk ratio (avg. winner/avg. loser) was 2.29:1. For ever dollar lost I made $2.29 back. And again, only for this scenario.

Had I bought long term positions buying options that are further out in expiration, debit spreads might do the trick for a directional play. In fact, for more experienced traders, I would wait and leg into the bull call spread.....taking the short side as the stock rallies higher.

And eventhough I hit on average 65% winners with a 1.80-2.50:1 risk ratio, in now way am I going to over leverage myself and take on more options than I need to, especially when the IVs are this higher already. It takes great money management along with a strategy to win. On average, I'll risk no more than 10%, 15% if my research shows that I have a greater probability of being correct, and 5-6% if research gives me a 60% odd of being correct. If my research gives me no direction on the move, then I'll skip it.

Remember, I'm playing earning trades on a 1-2 day time frame with expected 10-15% move on the underlying stock. What I'm doing here is that I'm expecting my research to help me overcome IV crushes, and that's how I came out with IV=50 and stock makes 10% move, options will hit 100% everytime. IV=75 and stock makes 10% move, options will only gain 75% on average. IV=25-30 (low vol stocks like MSFT, GE, PFE, IBM too) and stock makes 5% move, options will gain 100%, on 10% move options will make 200%. And I'm not using any formulas here, just from experience with earnings trades 2-5 times a week 50 weeks a year.

Play this game long enough, and you'll see moves like PCLN and FLR (after earnings report) before the move occurs. Options are risky, and gains aren't guaranteed, but if your odds are 99%, play it. Just use sound money management in case that 1% hits you.

Good luck and we'll test how NTES turns out tomorrow morning. I didn't mention what would happen if the stock turns lower, but I'm sure we both know the results for both strategies.
 
Quote from VictorS:

Terrific Journal!!!!
More...

Thanks VictorS, hopefully, all the IV talk gives you a clue as to that affect of IV on stock options.

At this point just embracing for a wild afterhours with CRM and NTES

I did close out UPL June 95 calls 10 at $3.60 just as the market sold off on the darn minutes. Net gain was $1074.10.

Still holding onto 10 ARD June 55 calls now at $2.25.

and for earnings closed out 7 AZO calls at $1.50 for a loss of ($1164.10)

Still have 10 CRM June 70 calls for earnings tonight,

and 15 NTES June 25 calls for earnings tonight,

and a bull call spread using 5 NTES June 25/30 call with initial cost at $1.00.

Hope earnings turn out well, but its a speculative game so good luck all.

Overall acocunt, net gain/loss is +$2162.30 since journal started.
 
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