MSFT & AMZN - UPDATE: Earnings Vol and Skew "Pair Trade"

Discussion in 'Trading' started by livevol_ophir, Jan 29, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    You can see the obligatory vol crushes after earnings in both AMZN and MSFT. The discussion from yesterday setting up the pair trade is available in the article today.

    The Skew charts from yesterday (pre-earnings) and today (post-earnings) are included in the article.

    So what was the hypothetical winning pair trade yesterday?

    <b>Version 1</b>
    Assume we wanted to be <u><i>contract</i></u> neutral
    (1) Sell 1 Front AMZN ATM (125) straddle --> Collect 14.75
    (2) Buy 1 Front MSFT ATM (29) straddle ---> Pay 2.29

    Today:
    (1) Buy 1 AMZN straddle back ---> Pay 10.10
    (1) Sell 1 MSFT straddle back ---> Collect 1.45

    PnL = (14.75 - 10.10) + (1.45 - 2.29) = $3.81 (i.e. make $381 for each pair of straddles).

    But the risk yesterday could have also been seen as a vol (vega) risk.
    <b>Version 2</b>
    Assume we wanted to be <u><i>vol</i></u> neutral
    (1) Sell 1 Front AMZN ATM (125) straddle ---> Collect 14.75: get short ~120 vol points
    (2) Buy 1.5 Front MSFT ATM (29) straddle ---> Pay 2.29: get long ~ 120 vol points

    Today:
    (1) Buy 1 AMZN straddle back ---> Pay 10.10
    (1) Sell 1.5 MSFT straddle back ---> Collect 1.45

    PnL = (14.75 - 10.10) + 1.5*(1.45 - 2.29) = $3.39 (i.e. make $339 for each pair of straddles).

    That's the winning trade. If you follow the belief that the vol was spiking do to dual phenomenon (link in prior blog) and watched the AAPL vol crush - you might have been lead to do this trade. Of course, finding the right trade after the fact is pretty damn easy...

    You can see from the skew charts (before and after) that the AMZN straddle was the better sale relative to MSFT without going through the whole trade analysis as well. Just look at the dip in the AMZN red line (front month) relative to MSFT.

    Details, skew charts, prices available here:
    http://livevol.blogspot.com/2010/01/amzn-msft_29.html
     
  2. Yehhh, finding the right trade after the fact is pretty damn easy...

    Going into earnings, what would make you think that buying a straddle on a $29 stock would be a good hedge for a naked straddle on a $127 stock and therefore a good pair?
     
  3. livevol_ophir

    livevol_ophir ET Sponsor

    http://livevol.blogspot.com/2010/01/amzn-msft.html