Most cost-effective strategy for being gamma-delta neutral, short vega, long theta?

[TSLexi]

Hi guys!

I'm wondering how to play an IV crush post-earnings. Obviously the strategy needs to be gamma-delta neutral, short vega, long theta, and be put on the day prior to earnings release.

I know that a gamma neutral position can be put on by using the gamma of the short leg * 100 as the number of contracts to be long, and vice versa, and you can hedge delta with the underlying. And since you're selling more options than you bought, position vega will also be negative, same for theta.

So I guess a ratio spread would be the answer?

I *really* wish I could afford LiveVol Pro, or better yet Silexx Obsidian Pro.

 

[oldnemesis]

I don't know what is the 'most cost effective' strategy but the simplest one for me is a calendar spread where you sell the close-in option and buy the further out option, delta hedge and wait for the crush.

e.g. IBM
going into earnings tonight, on a simple April/May 200 call spread the April call had a volatility of 55.1 while the May call had a volatility of 18.1.

Of course delta hedging is critical as IBM has slipped from 196.40 to 188.20 in after market trading.

I don't know if simple delta hedging with stock would work if the stock moves a lot. It seems the more the anticipation and thus the higher the volatility difference the more the stock will move on the report and thus you are in danger of losing in delta what you gain in the change in volatility... not to mention being a retail trader and paying the bid/ask spread. In this example the April 200 call had a .15 bid ask spread.

 

[sle]

You have a number of choices, each one presents it's second order risk that just might kill you. The general thought is that you can either combine options along the term structure (bad idea in this case, as TS will react to the earnings passage) or combine options along the strike space (probably better, but your second order greeks with respect to the underlying will be significant). You don't really need Livevol or any other tools, the Excel addin I posted here a while ago is plenty to build a toolkit to scan for opportunities.