I'm still learning about option strategies so please pardon my lack of knowledge. I've been thinking about earnings plays for the past few days and I've noticed that a lot of stocks make a big move one way or the other, consistently, on earnings news. I'm sure this isn't a new idea but what about buying a call and a put before the earnings news comes out and using fairly tight trailing stops on each to minimize loss on the losing option and maximize profit on the winning option? Have you done this before with any success? It seems like it will work very well as long as you find a stock that consistently moves big one way or the other on earnings. Thoughts?
The earning is one of the biggest forces that propel stock into the sky. The problem is that the well known past and current earnings are meaningless, doesn't include in the equation. Only future or potential earning is meaningful since stock is traded for future. That's why some company report a profit but its stock sinks and inversely another company report a profit and its stock skyrockets. The thing is how can we predict company's future earning?
Another important concept to understand is implied volatility for your 'strategy'. option prices are sensitive to changes in implied volatility. The higher the volatility, the higher the expected range for the stock, therefore the higher the price will be for the option. It is common knowledge that stocks have more of a tendency to 'gap' during earnings. How does this affect volatility? Naturally it creeps up higher and higher the closer the earnings announcement is. So, if you bot a call(bullish) the day before earnings and the stock moved in your favor by 5%, you still might lose money on the trade. Why? because the earnings event is over and implied volatility returns down to previous levels decreasing the value of your call options. I hope that helps.
"using fairly tight trailing stops on each to minimize loss on the losing option and maximize profit on the winning option?" Earnings play is either hit or miss most of the time. You have no idea what you are talking about.
So if a stock consitently moves a lot one way OR the other after earnings, I don't know what I'm talking about? Remember I said buy a call AND a put. I haven't heard about the option volatility scenario so I'll have to look into that more but I don't see why this can't work. For instance, Alcon's movements after the last 2 earnings announcements. On 10/17/05, 2 days before earnings, ACL closed at $127.99. After earnings, the stock steadily rose to a little over $140 over the next few weeks. 2 days before the most recent earnings, ACL closed at $122.70. After earnings, the stock fell to $110.25 over the next few days before moving back up. Unless the option volatility is that severe, I would think that whoever did what I'm talking about during those 2 plays made a lot of money.
Sure, buying straddles(long call+long put) around earnings is a popular strategy. Just don't buy the straddle a day before earnings because you will be paying a premium on your premium, most of the time. So, my advice would be to buy the straddle a few weeks before earnings come out before all that geared up volatility is priced into the options. Kapeesh?
I get it, that way volatility won't kick my ass. You have to admit though, those moves by ACL the last 2 earnings were pretty strong. Especially the first one. I think they report earnings on the 24th so it may be too late this time around. I'll start looking for some companies that don't report until the 28th or so and paper trade them. Thanks for the advice.
I've got a question now that I know a little bit more about this. I use optionsXpress and I noticed that the actual straddle can be purchased itself instead of purchasing the call and put seperately. I would assume that a trailing stop can't be used on just the straddle purchase but it can be used if the put and call are purchased individually. What are the advantages/disadvantages of doing it either way? IOW, if I purchased them seperately and one started to move in a profitable direction, could I stop out of the losing one and place a trailing stop order on the winning one? Or is it better to just hope for a really big move in either direction to compensate for the loss on the other side?
I don't know man, call your broker, he'll know what would be more advantageous for you. I don't use optionsxpress, but if you're hellbent on using stop loss, enter orders separately, but u'll probably be charged another ticket charge. Call them to be sure tho.
Just remember you win some and lose some on straddle plays. The stock has to move more than what the premium cost you, not to mention you also have to deal with the factor of time to expiration etc. In other words, it is not as easy as you thought, or else everyone here would be doing them.