Since I am slowly turning into a neutral strategy monkey, except for that incredibly (and inversely) death-defying, stubborn, mechanical MensaMonkey, I happen to notice that earning were coming out for Nvidia (NVDA) on May 9th after the market closes. On two past occasions I have used Nvidia as an example on how to use an option strategy called a "long strangle" which is a neutral strategy that involves the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.
Using today's price of Nvidia at around $13.83, the delta neutral play would be to use a similar strategy called a "straddle" which is also a neutral strategy in options trading that involve the simultaneously buying of a put and a call of the same underlying stock, strike price and expiration date.
If you know nothing about options you have probably already moved on, or are taking this opportunity to catch a few drooling ZZZZ's., but for the rest of you that have some idea of what a call and a put is, you may wonder what the point is of buying a call and a put of the same strike price. Don't they just off-set each other?
Price action of the underlying stock will move the price of the option...when the stock price goes up, the call increases in value while the put decreases in value; when the stock price goes down, the call decreases in value and the put increases in value. Other factors contribute to the price change of an option. The one we are most concerned with here is implied volatility.
Take a look at the line on the chart that represents implied volatility...
See the sharp spikes? These occur consistently as NVDA approaches the earnings date. We'll call this the volatility "rush". As implied volatility increases before the earnings announcement, this can cause the price of both the call and the put to increase, even if there is no price change in the underlying stock price. If there is a large price change in the underlying stock, this will usually result in an increase of either the call or put that results on an overall gain for the straddle (or strangle).
When using a pre-earnings straddle or strangle, I buy somewhere between one and five days before the announcement, and sell before the announcement rather than hold the trade through the announcement. So why do I sell just before the announcement since stock prices can make huge moves 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.
Another reason I buy only a few days prior to the earning date is because of the Theta-Monster. Theta is a measurement of the option's time decay. Yes, that's right, buy an option and the option loses value as time marches toward the expiration date. Think of theta as a little "Pac-Man" that slowly eats away at the price of the option. Conversely, and to confuse matters a little more, theta is your friend if you sell options, instead of buy them.
So what options will we be using for this round of NVDA straddling? We can go with the slightly unbalanced 14May call and the 14May put, currently trading at .32 and .48 respectively. One option equals 100 shares so move the decimal point over two places to the right and you will see that you are paying $80 for this not so quite neutral pair of options.
Now we "let bake" until near the end of the day on Thursday and see if the "dough rises". Of course, if some huge price move occurs before then, there's no need to hold the trade all the way through to the earnings date. (Mmmm..monkey likes bread.)
Related Post:
The Pre-Earnings Strangle
