Going into ER, all options increase in IV. The front month increases slightly more, but I have never heard of a discrepancy where this tactic would work, usually it is minimal at best.
With Calendars, you want to put them on when Implied volatility is low. The more extrinsic value, the greater the option reaction to changes in vega.
The short option can lose 1/2 of its premium while the long option might only lose 2/5s but since you paid more for the long term back month option, it is going to hurt your pocket more. A double calendar doesn't hedge against this because you have two long options that are still primarily composed of premium, just one is a put and one is a call.
May 2013 - 1
June 2013 - 4
Total amount invested: 3
May 2013 - 0.5
June 2013 - 2.5
Total amount remaining: 2
If price doesn't even move, you will lose money. In order to be profitable you need to be directionally right, AND you need the price move to exceed the time decay.
Here are some potential trades to go into an ER.
- Buy a long straddle/strangle if you expect a big move. Don't buy it the day before the E.R. when everyone else does or else you will be paying a premium.
- Buy call/put going into the ER and sell it @ the close prior to E.R. Everything else remaining equal, the option will be worth more going into the E.R. because IV will have increased the value of the option
Last edited by Bermudan Option; May 4th, 2013 at 10:10 PM.
Buying straddles/strangles heading into an earnings announcement can be tough. Even though it looks like the straddle will profit from the increased vol, it's also decreasing from theta. You might make money if the stock moves, but that's coming from movement and not volatility, which was the topic of this thread.
As for calendars, you need to look at each month individually and see how much each leg of the calendar profits/loses as the implied vol returns to 'normal' levels after the announcement. Sometimes the skew between the months is excessive enough to make one comfortable with the amount of stock movement needed to make the calendar a loser after the announcement.
The following user says Thank You to Greg Loehr for this post:
Here's another one. Not the best example, but something to watch for a "vol" trade.
Buying to open the GD Aug 82.50-85 strangle for about $2.50'ish. Subject to about a $0.64 vol crush, which is 25% of the trade. Needs about a $2.50 move to breakeven tomorrow, based on my assumption of the vol going to 17.