Straddles, are they ever profitable?

[Soon2Bgreat]

In an effort to be productive, I did a backtest of a long straddle pre-earnings. We know IV will rise up into earnings. The question is whether or not the rise in IV plus any moves in the underlying will compensate for theta decay to the point where the structure could be profitable.

This is just one example. I picked it out of thin air. While it's not demonstrative of any overall long-term profitability of being long straddles pre-earnings, it's just one case study.

See the image below on a pre-earnings straddle of Nike (NKE). It does not include commission costs.

View attachment 165419

Here I examined buying a straddle 4, 3, 2 and 1 week before earnings. We see IV rising but still, each attempt was not profitable because the underlying barely moved and theta decay ate our lunch. There may be some other intelligent filters we can implement that would help us choose better stock candidates that would have a better chance of profit just ahead of earnings, maybe comparing ATR or historical vol as a way to project larger directional underlying moves.

Again, this is just one example, but it reinforces my belief that in general options prices tend to be over-priced in the face of uncertainty, even if the date of the uncertainty event is certain.

I can imagine that people that were long straddles into Brexit were profitable, but counter-consensus shocks like that don't happen very often. I can imagine there is someone out there (Nassim Taleb?) trading the extreme tails, losing small amounts over and over again (95+% loss rate) until finally something like Brexit happens and they make it all back and then some (lots!), but that's some steely patience and it would be hard to manage client money like that.

Nice work.

Part of the reason long straddles tend to look so unprofitable is nobody includes the PL from delta hedging along the way. I'd guess the 4wk looks much better with the delta hedge PL.

...it often turns long straddles from unprofitable to profitable. I understand frequent delta hedging is costly but doing the exercise using cost-less hedging is instructive. Practically it's also more difficult leading into earnings since the underlying doesn't move much.

 

[sle]

The real question is - are you trading gamma (so actively delta hedging and paying/collecting theta) or vega (still delta hedging, but in long dated options where gamma is theta/gamma is negligible). Those are two very different trades - in the first case you are predicting realized volatility and trading implied volatility against it. In the second case, you are deeming implied volatility being too cheap or too rich and betting on the change.

 

[CBC]

have you traded commodities or only stock, did you have a Volatility scanner ? thanks

When I was trading straddles it was only stock. I've traded other stuff since like ES, 6E, 6A, ZN.

No Vol scanner, if the underlying was moving around a lot I would study it to see if I could trade it. Anything with flat trading would simply have its chart thrown in the bin.

I think the main focus needs to be on the underlying. The end result of the trade will be where the underlying ends up and they are called derivatives meaning they derive their value from a different source, so the source should be the thing studied.

 

[trilogic]

Thanks- moving around a lot ? Asin the ATR was above a certain level or had some sort of range ?

 

[trilogic]

The real question is - are you trading gamma (so actively delta hedging and paying/collecting theta) or vega (still delta hedging, but in long dated options where gamma is theta/gamma is negligible). Those are two very different trades - in the first case you are predicting realized volatility and trading implied volatility against it. In the second case, you are deeming implied volatility being too cheap or too rich and betting on the change.

How would you or anyone have an edge of predicting realized volatility so that one can trade implied against it ? Im sure it can be done but who is good at it and how much return and how measured >> thnx

 

[sle]

How would you or anyone have an edge of predicting realized volatility so that one can trade implied against it ? Im sure it can be done but who is good at it and how much return and how measured >> thnx

You can do it fairly well using a combination of backward-looking analysis (historical volatility, history of events) and forward-looking analysis (is the world better/worse now, is this even drastically different from previous ones etc). The less en vogue is your underlying, the less people look at it's vol and the more you can achieve with an analysis like this.

 

[trilogic]

So me trying to buy Vol . in gold is fools game ? Long run...

 

[sss12]

You can do it fairly well using a combination of backward-looking analysis (historical volatility, history of events) and forward-looking analysis (is the world better/worse now, is this even drastically different from previous ones etc). The less en vogue is your underlying, the less people look at it's vol and the more you can achieve with an analysis like this.

@sle ...if I'm interpreting correctly, you believe there is a good deal of subjectivity (vs objectivity) in trying to predict vol ? thanks.

 

[El OchoCinco]

If you could predict vols, we would not have an option market... predicting vols is the uncertainty that creates most of our derivatives markets,.

 

[lawrence-lugar]

Straddles, are they ever profitable?

Generally speaking, I would say No... Nothing in trading is easy or fixed or set it and forget it.
You need a certain degree of skill to execute and manage the trade successfully.

Trading is part art, part science. -- The sooner you realize that, the better you will be off.