When An Option Increases Nearly 9,000%

[Illini Trader]

A couple of members have alluded to it but the basic problem with your strategy is that the market makers build in such a large volatility premium into the pre earnings option price that it makes it virtually impossible to do what you want to do.

Lets take a live example today. TSLA reported earnings after the close and the closing price was 143.67. The last price paid for the FEB2 143 call was $11.74 and the last price paid for the 143 put was $11.32. So if you bought one of each you paid $23.06. The Market Maker expected move was plus or minus $22.72. If you do not get the expected move you are going to lose.

TSLA is trading at $156 in the after market up around $13. So your call has an intrinsic value of $13 and your put is toast. I did buy a 115 put and a 175 call so the jury is still out on me as I was counting on at least the expected move. I bought the monthly to have a little more time and may come out OK if the faithful following of TSLA keep a crazy premium in the OTM calls.

You are not the first person to have this idea and the Market Markers make it virtually impossible for you to profit consistently from this. Sure, take DATA last Thursday. It was a $82 stock and traded at $40 after earnings so any puts on that one made you a ton and I have a friend that did have puts on it. But like one member said most of your trades will be losses and occasionally you will have a huge winner. That is a tough way to trade and most likely a long term losing result.

 

[botpro]

A couple of members have alluded to it but the basic problem with your strategy is that the market makers build in such a large volatility premium into the pre earnings option price that it makes it virtually impossible to do what you want to do.

I just wonder: can the trader not make use of that guaranteed fact the MMs doing with the volatility before ERs? ;-)
Ie. by just buying it some weeks earlier: the trader will profit once from the increased vola right before the ER, and then hopefully profit also from his ER outcome strategy...

 

[Jones75]

I just wonder: can the trader not make use of that guaranteed fact the MMs doing with the volatility before ERs? ;-)
Ie. by just buying it some weeks earlier: the trader will profit once from the increased vola right before the ER, and then hopefully profit also from his ER outcome strategy...

Jeff Augen wrote a book that explains the pre earnings concept. I tried it a few times, but found theta was too severe. Plus, carrying anything over the weekend, too grinding for me.

I find playing selective earnings, like small cap or the lower end mid cap, vol relatively in line with historical, bloated P/E's, and something else out of whack (P/S, P/B or short ratio etc.) the most lucrative. Use good money management, and it keeps the losses to a minimum.

IMHO using the "Long Put Synthetic Straddle" keeps the greeks more in check and only have to deal with the puts, and the way the markets are these days, too hard to predict.

 

[Jones75]

O, I forgot to add, the bid ask spread, you know slippage, has become my Achilles heel. Would like to see that regulated some how.

 

[AlphaRocks]

I just wonder: can the trader not make use of that guaranteed fact the MMs doing with the volatility before ERs? ;-)
Ie. by just buying it some weeks earlier: the trader will profit once from the increased vola right before the ER, and then hopefully profit also from his ER outcome strategy...

The problem w/that strategy is that you have delta and theta risk, and systemic risk from macro events, econ data, FOMC, etc. all while you wait for vol to rise... so your long straddle/strangle will be way off from ATM (delta risk), and eroded time decay (theta) by the time the earnings event comes around. Like I said on my prior posting long straddle/strangles on front contract on earnings event don't work most of the time.

 

[syswizard]

Like I said on my prior posting long straddle/strangles on front contract on earnings event don't work most of the time.

It would be interesting to see the performance difference between a directional debit spread vs. a long straddle for pre-earnings announcements. Even if you are only right 50% of the time on the direction, would that surpass a long straddle strategy I wonder ?

 

[AlphaRocks]

It would be interesting to see the performance difference between a directional debit spread vs. a long straddle for pre-earnings announcements. Even if you are only right 50% of the time on the direction, would that surpass a long straddle strategy I wonder ?

From my experience (I don't have collected hard data -- maybe someone can backtest it), I would say the debit spreads are more likely to outperform the long straddles, because the short leg of the debit spread will absorb some of your losses, so you're likely to lose less on the failing trades. And the times when the straddle outperforms the debit spread that gets capped on profits by the short leg, would be too far few to make up the difference in profits -- these are the outlliers.