No volatility crunch?

C

countdrak

I am newbie at this but wanted someone to help me understand a trade.

I bought a Yahoo straddle in the morning when the earnings were going to be announced in the evening. I know bad move! I have read a lot about how volatility increases in anticipation of earnings and right after the earnings the volatility goes back to normal. Also I have read how it makes sense to sell the options before the earnings to not get hit by volatility crunch.

Here is my trade -

YHoo - Call - Strike 27.00 - July Expiration - 0.71c
Yhoo - Put -strike 27.00 - July Expiration - 0.51c

Now the interesting thing was that when the results were announced and the stock moved 10% the next day my call (which I sold!) was worth $2.69, naturally the put went to 0.

The call still is worth more than I paid for today and expiration is tomorrow!

What happened here? No volatility crunch? Did I somehow end up with a cheaply valued call? I am not complaining, I made money. Just want to understand how the fluke worked so I can try the same strategy next time.

Thanks/
 
The call was worth what it should have been worth. Take the strike price, 27, add to it the premium you received for it when you sold it, and then compare that to the price of the stock when you sold the call.
 
So you are saying - There is no volatility component, there is no time value?? It is as simple addition/subtraction problem? Why did this option move linearly when others don't move?
 
Quote from countdrak:

So you are saying - There is no volatility component, there is no time value?? It is as simple addition/subtraction problem? Why did this option move linearly when others don't move?
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you need to read up on options more. you need to understand greeks and you need to understand how time effects the price as well as what the price should look like with no time to maturity, and why
 
Quote from countdrak:

So you are saying - There is no volatility component, there is no time value?? It is as simple addition/subtraction problem? Why did this option move linearly when others don't move?
More...

The option was in the money by about 10% and expiration Friday was just two days away when you sold it. You should expect the option to have very little time value in that situation.
 
For a while I was experimenting with buying straddles before earnings but it was like 1 or 2 weeks before, not 1 day before. The idea was to buy low IV and sell higher IV right before earnings i.e. I did not hold past earnings.

This was based on the observation that on some stocks IV ramped up before earnings pretty reliably. The trick was to find the right stocks with the historical IV ramp and to get out before earnings. You wanted to buy the straddles soon enough that IV hadn't started ramping up yet but theta wouldn't take away too much of potential profit.

So you have the right idea that IV increases in anticipation of earnings but the wrong timing.

I used optionslam.com for finding my straddle candidates.
 
Guys - I appreciate all the details. Reading a lot, absorbing some! :)

The only thing I was really after from this post was - Why does volatility drop crush some options prices (they don't move after earnings day) VS this trade where it did move is right direction for me.

Need to read up on greeks!
 
You can't say that there was no volatility crunch. Your profit was due to a large move in the stock, not a lack of decline in volatility. Like I said, or meant to imply anyway, the call you bought did not have much volatility priced into it when you sold it. Most of its value was intrinsic value.
 
Yeah, Josef K is right. Really you accidentally made money on that straddle just from luck.

What happens is the market prices the straddle according to the movement it expects. So if the market expects a 5% move then IV adjusts accordingly and the straddle price anticipates a 5% move. If you buy a straddle and hold it past earnings you'll generally lose money or break even because of this. The only way to make money in earnings straddles is to have a movement greater than the market predicted. That's what happened in your trade.

Obviously this doesn't happen all the time or everyone would do it and be billionaires.
 
Quote from stevegee58:

For a while I was experimenting with buying straddles before earnings but it was like 1 or 2 weeks before, not 1 day before. The idea was to buy low IV and sell higher IV right before earnings i.e. I did not hold past earnings.

This was based on the observation that on some stocks IV ramped up before earnings pretty reliably. The trick was to find the right stocks with the historical IV ramp and to get out before earnings. You wanted to buy the straddles soon enough that IV hadn't started ramping up yet but theta wouldn't take away too much of potential profit.
More...

I've played with this strategy a few times as well, and the problem is clearly stated in the bolded part above.

Even with a ramp up in IV, the theta loss will cost you more. So you get to expiration with a much higher IV than you started with, yet you're still down money.

A long straddle is long IV, but also long gamma/short theta. And the gamma portion will usually dwarf the IV portion. So your profit/loss from buying a straddle will mostly be determined by gamma or stock movement, and very little from IV movement.
 
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