Trading Pre-Earnings Implied Volatility Increases

R

rivercode

So it is well known that IV will rise significantly before earnings and then "crash" after the earnings announcement.

But the challenge becomes how do you take advantage of this ? What strategy can you use to get a good theoretical and practical edge ? The key here being a practical edge that takes into consideration what the market does. For example, you will hear buy a near term ATM and sell the longer term ATM...go ahead and model and then you will see why the markets are efficient. Another idea is to do a pairs trade, eg. INTC/AMD or against an ETF like SMH...does not really work in practice. For example, with the INTC/SMH pair...the IV of the SMH almost increases at the same rate as INTC during INTC pre-earnings periods.

So my Q is simple...what can be done to make a profit from pre-earnings IV increases ?
 
Mind you, I haven't tried this. But let's suppose you looked at how much IV typically increases prior to earnings reports, and determined the upper 10% of that range. Let's further suppose that you then systematically sold premium delta-neutral on those stocks whose pre-earnings IV rise fell into that upper 10% range. You'd get whacked from time to time but overall, I suspect you'd make money.

As a refinement, let's say the surprises tended to be more often negative than positive. You could adjust your deltas to have a negative bias then.

Just thinking out loud.
 
Quote from rivercode:

So it is well known that IV will rise significantly before earnings and then "crash" after the earnings announcement.

But the challenge becomes how do you take advantage of this ? What strategy can you use to get a good theoretical and practical edge ? The key here being a practical edge that takes into consideration what the market does. For example, you will hear buy a near term ATM and sell the longer term ATM...go ahead and model and then you will see why the markets are efficient. Another idea is to do a pairs trade, eg. INTC/AMD or against an ETF like SMH...does not really work in practice. For example, with the INTC/SMH pair...the IV of the SMH almost increases at the same rate as INTC during INTC pre-earnings periods.

So my Q is simple...what can be done to make a profit from pre-earnings IV increases ?
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From a stock perspective this is what i do.
I sell the put and call (same strike) going into earnings. I trade the stock during earnings. If stock ABC has real bad earnings i hold my short overnight until i can sell out of the options. Im decently quick trading earnings, so it works out ok.

This usually works for me except when the stock is halted into earnings. Or if a stock has real good earnings or real bad earnings and my max gain is what i make on the put and call and not my stock position
 
Quote from rivercode:

...what can be done to make a profit from pre-earnings IV increases ?

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Confirmation of the obvious.......
1) Be willing to buy father-out-of the-money calls/puts/straddles/strangles with the expectation that beneficial price and volatiltiy movement will occur, as expected or bigger than expected 2 to 3 weeks before the news announcement.
2) Be willing to reverse the position a few days before the report and carry it through with the hope that the "vol" gets crushed and the price remains stable.
3) Start out on a small scale with larger-cap companies so as to reduce the possibility of an "April-2008 GOOG Surprise".
 
Would add a long otm strangle to the naked short straddle be better. If you just do a naked short straddle, and the news gaps in either direction you are screwed.

In the current market condition, this has happened quite often - anytime there is surpirse the stock just gaps ie: goog, nflx, ibkr, nvda. You definitly dont want to be caught holding a short straddle on any of them.

Only time i play earning is when market expectation and price is already so high that it's very difficult to meet. Then i do a straddle with a downward delta bias.
 
I should clarify my Q....

Everyone is looking for an edge and there are very few to be found and even fewer things one can predict in advance. IV increase on certain stocks pre-earnings are pretty predictable though the range will vary.

My Q...is it possible to try and capture that IV increase to turn it into a profit ?
 
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