Earning day out of money options trading strategy

Discussion in 'Options' started by etherboy, Jan 29, 2008.

  1. etherboy

    etherboy

    I'm new to options.

    I'm wondering how many people using neutral strategy on a stock's earning day by buying out of money options on both upside & downside?

    And how successful you are?

    Take VMware yesterday's earning report for example. VMware close at $83. Out of money options $100 February call cost you $0.55 and out of money options February $60 put cost you $0.75.

    So if I'm buying 10 contracts for both sides, it will cost me (0.55+0.75) x 10 x 100 = $1300.

    But since VMW dropped to $55, now $60 put is worth $6.30 and $100 call is worth $0.05, so my profit will be $6.35 x 100 x 10 - $1300 = $5050.

    What will be the worst senario on this kind of trading?

    If there is another thread about this kind of trading, please direct me there, thank you.
     
  2. MTE

    MTE

    Worst case scenario is the stock not moving or not moving enough. VMW was more of an exception. In other words, strangles don't always work, cause the stocks don't always drop or rise by this much. Essentially, buying a strangle or straddle is a bet that the market is underpricing the move. Sometimes it does and sometimes it doesn't. Without some specific way of finding these kind of big movers, you'd be lucky to breakeven.
     
  3. Unless you know something which sure information, that is not how you play earnings. There ways to play them:

    1. Vol play (buy vol at the money, sell it out of the money). IV_Trader is I think the expert on this. Check his posting.
    2. Reverse calendars. (Spindr0 is the expert on this,check his
    posting).
    3. OTM butterflies (short strike is out of the money).

    All of these are specs trades. No more than say 20% of your porfolio should be allocated to this. I would not risk more that 1/20 of this 20%, which equals 1% of an account.

    Good luck
     
  4. This is one of those beautiful hindsight trades where we're all counting the money on the way to the bank from the trade we should have placed. In reality, buying straddles and strangles results in some occasional beauties like this and a whole lot of partial to 100% loss of the premium paid for the options (depending on whether you bother to salvage pocket change from the failures). Unless you have some edge in stock picking (movement) or volatility estimation, you're not going to get rich from these. In fact, you're not going to get rich from options anyway :)

    The worst case scenario is:

    1) The underlying doesn't move enough to be profitable

    2) Since it's an earnings play, you're going to pay up for the options because the implied volatility is going to be inflated and after the EA, it's going to contract. Because of this, you're going to need a fair amount of movement just to break even.
     
  5. RFT, Thanks for the kind words but I'm no expert at anything... unless you count the number of strategies that I've tried :)
     
  6. I bought 200 contracts VMW Feb 2008 70.00 puts yesterday. When I went to close the position I found out that I was using my demo account. :mad:

    This is a true story.
     
  7. You have to connect historical binary outcome with current (report day) IV/primium . This ratio is also depending on days left to expiration. And , yes , OTM ( or far OTM) will yield the best result , although win/loss ratio will be negative.
     
  8. etherboy

    etherboy

    So if the stock don't move at all, the premium for both side will contract, maybe by a large margin and I'll lose.

    Guys, thanks for all the inputs and directions. Need to learn more here.
     
  9. 2) Since it's an earnings play, you're going to pay up for the options because the implied volatility is going to be inflated and after the EA, it's going to contract. Because of this, you're going to need a fair amount of movement just to break even.
    --------------------------------------------------------------------------------

    A way to negate much of the problem with IV contraction post EA is to utilize spreads. Loosely speaking, what you overpay for the long leg is offset by what you receive by selling the short leg.
     
  10. You're making an assumption that you know something that the market does not when you buy out of the money options for earnings plays. In general straight buying of out of the money options for earnings historically has been a loser.
     
    #10     Jan 30, 2008