Hypothetical Trade

Discussion in 'Options' started by erol, Apr 15, 2009.

  1. erol

    erol

    Hello,

    I'm wondering if this trade makes sense, given that I think it'll move, but not sure by how much.

    Earnings are coming out shortly, I'm bullish, but unsure if they can meet earnings.

    Current price is >31. What I'm thinking, is buy a JUL ITM 28 call, and profit from the downside with a MAY 31 PUT.

    Once I know the direction, I sell the losing side and hope that over the next few days I can profit from the trade.

    Is there a better way to go about this? Am I over-complicating this or would a strangle/straddle be better?

    thanks in advance for your input!
     
  2. there are a thousand ways to skin the cat.
    dont complicate.
    I wud prefer to
    use a strangle/straddle. if u can guess the range.
     
  3. There are several problems with your strategy.

    If earnings are coming shortly, more than likely, you're paying a volatility premium for the options, Once earnings are released, IV contraction will cause the premiums to drop. If there's a lot of pre-earnings expansion as well as post release contraction, the more the loss just from a news event.

    Becauser the stock is over 31 and you're using an ITM 28 call and an OTM 31 put, the P&L is bullishly skewed. Depending on the IV as well as the time you're in the trade, it might take 3+ pts to break even on the upside, maybe double that on the downside (less if you cut the losing side quickly). It won't be pretty.

    And then there's the mild complication of diagonalization.

    Any trade can work but pre-earnings straddles, strangles and variations therof have a lot going against them. IMHO, if your earnings play bet relies on not knowing the direction, something that takes in premium as well is a better approach, eg. double diagonals, calendar strangles, etc.... and often, ratioed.
     
  4. Best way to play earnings, IMHO, is to look for companies that announce earnings the week of options expiration. For example, suppose AAPL will announce earnings on the Monday evening of that week. Purchase an ATM or slightly OTM call if you expect AAPL to beat. If, on Tuesday, you get upward movement, you can then sell the stock short. This will lock in the profit from the pop. It will also protect you from any downside risk. Example, suppose AAPL trades at $100.00 at the open Monday. You purchase a 100C for 1.00 at the open. Suppose, on Tuesday, AAPL pops to 102. At that point, sell the stock short. If the stock continues to move up, you still lock in your profit of 1 point. If the stock then tanks after the pop, you will also profit if it tanks below 99 by expiration.
     
  5. Interesting hypothetical example.

    I know that you know the ATM call in a $100 stock - especially one with a high IV - is not going to cost a buck.

    Mark
     
  6. All this guy was propsoing is what we would call a mombo combo, or a gut strangle. it would be cheaper and easier for him to execute this trade the opposite way. Dont you guys think? as far as I am concerned I think it would be much cheaper and easier to just put small time bomb butterflies where you think it might end up.

    Mark
    www.option911.com
     
  7. erol

    erol

    thank you all!

    time bomb butterfly???

    wow... i love these names.