The Pre-Earnings Strangle

Sometimes I think that options are just a more exotic way for the market to take my money. With that attitude, I sometimes straddle or strangle a stock that is approaching earnings. This way I can make a profit without knowing or caring which direction the stock price will move. I won't bore you with defining all the terms that options carry with them but I will give you the reason behind using this strategy prior to earnings announcements.

Let's use the example of NVDA which has an expected earnings announcement next Thursday after the market closes. Since the price just after the open today was around $13.60, I decided to use a strangle and buy the out-of-the-money August 14 calls and also buy an equal number of the out-of the-money August 13 puts. If the price were close to 13 or 14, I would have used a straddle and bought an equal number of puts and calls using either the 13 strike price or the 14 strike price. The plan is to be as delta neutral as possible. Delta is a measure of option value changes to changes in stock price. Clear as mud?

I have five full days until I sell BEFORE the earnings announcement. The price of a bought option declines due to theta (that's Greek for "time eating price) so I buy only a few days prior to the announcement. This type of trade will become profitable if the stock price moves significantly or if the implied volatility increases as the announcement approaches...and it often does as the chart below indicates by the look of all those spikes around the earning dates. If implied volatility increases, the price of the options (calls and puts) can also increase.

So why do I sell before the announcement since stock prices can really move in one direction or the other after an announcement is made? Just as there is a volatility "rush" into earning there is also volatility "crush" after an announcement which often deflates the price of an option even if there is a significant price move.

The beauty of using a straddle or strangle prior to earnings is that risk/reward makes this a relatively safe play...unless you don't believe me and hold through earnings. On Friday, near the open, I bought the August 14 calls for .33 and the August 13 puts for .37.  Let's see where this ends up over the next few days.

If you want to learn more about options, there are plenty of really lousy books on the subject. I think these guys do that on purpose or they have been in the business so long that that they just can't communicate anymore. It's like asking Albert Einstein how to tie a shoelace.

Here is one of my recommendations for learning options if you don't have a clue, and really want one...Options Trading 101 by Bill Johnson