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How to make money on Volatility before earnings?


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How to make money on Volatility before earnings?

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  #1 (permalink)
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Hello everyone. Im testing my strategies on increasing volatility before earnings release. But i need some professional
advice from people who is successfully making money on volatility.
I would really appreciate if anyone would share any ideas or strategies they use.

Thank you in advance.

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  #3 (permalink)
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You can buy volatility before earnings with time spreads and sell volatility right before earnings with verticals.

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  #4 (permalink)
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traderwerks View Post
You can buy volatility before earnings with time spreads and sell volatility right before earnings with verticals.

What are you mean buy with time spreads?

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  #5 (permalink)
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esby06 View Post
What are you mean buy with time spreads?

I assume a calendar spread. For trading volatility, you could also look into a straddle or strangle.

Btw, Cohen has written two good and accessible books on option trading: options made easy and volatile markets made easy. Perhaps worth checking out.

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  #6 (permalink)
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"Buy volatility with time spreads" - does that also mean buy at relatively lower volatility?

Time spreads are calendars.
The "front" month is the closer month. Usually an option (call or put) is sold at an underlying price.
The "back" month is usually a month later. Usually an option (corresponding call or put to front month) is bought at same underlying price.

I assume he means "sell volatility with verticals" by using iron condors.
An iron condor consists of two vertical spreads.
The two vertical spreads usually consist of:
A bear call spread (bull credit spread) on the right, and a bull put spread (bear credit spread) on the left.
And the center of the IC is near ATM.

The term "vertical" refers to the same month for both legs of a vertical spread.So slightly different prices for the component option legs of a vertical spread but both options in the same month.

Both right and left credit vertical spreads in the IC are all in the same expiration month.

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traderwerks View Post
You can buy volatility before earnings with time spreads and sell volatility right before earnings with verticals.

Thanks for the tip. What about in relation to option expiration if you don't mind giving an answer that is? Is there also a similar strategy for timing the placing of spreads before, at and right after option expiration?

Just remember, OP, price fluctuations can still ruin a spread position real quick. There are ways and attempts to plan for that, but it's a dangerously tricky art which I'm still trying to figure out.


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  #8 (permalink)
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It all depends on what trade you are trying to do and how far until expiration.

I remember selling a bunch of spreads before an Apple announcement, that was 10 days before expiration. When the volatility died ( Implied volatility ) after the announcement, I just had to sit on them for the week. The price moved but the IV fell so much, no one was even quoting those options any more.

Each situation is different and how it relates to the catalyst you hope happens ( or not to happen ) depending on what your trade it attempting.

I will start reading your journal.

TW

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  #9 (permalink)
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Back to the original post for earnings announcement. Prior to the announcement you would expect the
near term option to have higher than normal IV.

The far month IV hopefully would be near normal or only slightly elevated.
There may be a difference between near term IV and far month IV. Near term a good
percentage higher.

Buying a double calendar at strikes not too far from the price should mean a good price for the
calendars.

After earnings release the IV of the near term may decline significantly, resulting in a gain in the
double calendar.

But beware, real life does not always work as theory might predict.

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  #10 (permalink)
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Alternatively, you can take a look at the ATM straddle for the front month. Take about 85% of the value of that straddle to get the implied move. Next sell an Iron Condor for a net credit with the with of a bit over the implied move to play for a volatility crush after earnings. This trade assumes that you do expect the stock to trade within the implied/ defined move of your condor.

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datahogg View Post
Back to the original post for earnings announcement. Prior to the announcement you would expect the
near term option to have higher than normal IV.

The far month IV hopefully would be near normal or only slightly elevated.
There may be a difference between near term IV and far month IV. Near term a good
percentage higher.

Buying a double calendar at strikes not too far from the price should mean a good price for the
calendars.

After earnings release the IV of the near term may decline significantly, resulting in a gain in the
double calendar.

But beware, real life does not always work as theory might predict.

Hmm.. Have you actually traded this, because it does not look like it would work with calendars.

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  #12 (permalink)
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traderwerks View Post
Hmm.. Have you actually traded this, because it does not look like it would work with calendars.

I started a similar thread here:

I have screen shots of the options before and after earnings as well as a chart showing the vol crush, so you can research a few scenarios if you like.

I've been toying with IC's on options with high implied over historical (usually this is before earnings) anyway 3 of the 4 spreads worked out, with the last in AKAM being a loss

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lrfsdad View Post
I started a similar thread here:

I have screen shots of the options before and after earnings as well as a chart showing the vol crush, so you can research a few scenarios if you like.

I've been toying with IC's on options with high implied over historical (usually this is before earnings) anyway 3 of the 4 spreads worked out, with the last in AKAM being a loss

I meant with calendars, not an IC.

I am quite familiar with vol crush.

Anyway, I will leave this thread alone.

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  #14 (permalink)
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datahogg View Post
Back to the original post for earnings announcement. Prior to the announcement you would expect the
near term option to have higher than normal IV.

The far month IV hopefully would be near normal or only slightly elevated.
There may be a difference between near term IV and far month IV. Near term a good
percentage higher.

Buying a double calendar at strikes not too far from the price should mean a good price for the
calendars.

After earnings release the IV of the near term may decline significantly, resulting in a gain in the
double calendar.

But beware, real life does not always work as theory might predict.

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.

Before E.R.
May 2013 - 1
June 2013 - 4
Total amount invested: 3


After E.R.
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

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  #15 (permalink)
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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.

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  #16 (permalink)
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Here's an idea for AAPL earnings today after the close:

Buy Aug2 425 calls,
Sell Aug1 425 calls,
As a long calendar spread for a debit of $0.65.

Should be "safe" in about a 30-point range.

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  #17 (permalink)
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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.

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Another option is an in the money strangle. For starters there's a higher probability of being profitable

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Greg Loehr View Post
Here's an idea for AAPL earnings today after the close:

Buy Aug2 425 calls,
Sell Aug1 425 calls,
As a long calendar spread for a debit of $0.65.

Should be "safe" in about a 30-point range.

I am trying to get some Diagonal backspreads in my life but they chew up so much margin

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Bermudan Option View Post
Another option is an in the money strangle. For starters there's a higher probability of being profitable

By ITM, do you mean one option or both options ITM? Not sure how that increases the chances of profit.

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  #21 (permalink)
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AAPL calendar is up 46%; GD strangle is down 5%. Put them together and that's a nice return for one day.

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Greg Loehr View Post
AAPL calendar is up 46%; GD strangle is down 5%. Put them together and that's a nice return for one day.

The BID ASK spread is pretty wide on the AAPL calendar, how did you unwind the trade?

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Greg Loehr View Post
By ITM, do you mean one option or both options ITM? Not sure how that increases the chances of profit.

Sorry I should have said it decreases the degree of losses relative to the investment. I mean buying both options ITM btw. It requires a bigger investment, but the profit potential is still unlimited while it is impossible to lose 100% of your investment. Both options have intrinsic value, so any intrinsic value you lose on the call is added onto the put and vice versa.

Since the options are both in the money, your exposure to high IV prior to earnings is greatly reduced.

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  #24 (permalink)
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As for the calendar and wide bid/ask spreads: no reason to close calendar yet because I think the price will continue to improve. The wide bid/ask spreads aren't necessarily a problem because I know AAPL is very liquid.

As for the ITM strangle: that trade is no different than buying the OTM strangle with the same strikes. You're paying for the real value of the options, which just offsets and does nothing for you.

It gives you no advantage, but probably costs you more in slippage because of the wide bid/ask spreads.

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Greg Loehr View Post
As for the calendar and wide bid/ask spreads: no reason to close calendar yet because I think the price will continue to improve. The wide bid/ask spreads aren't necessarily a problem because I know AAPL is very liquid.

As for the ITM strangle: that trade is no different than buying the OTM strangle with the same strikes. You're paying for the real value of the options, which just offsets and does nothing for you.

It gives you no advantage, but probably costs you more in slippage because of the wide bid/ask spreads.

I disagree. The intrinsic value of a OTM strangle is $0.00. If they don't get any intrinsic value after and Earnings Report, then they are will lose value dramatically as IV implodes. On the other hand, an ITM long strangle has intrinsic value... It is a strangle, so you are expecting a big move in one direction or another. Initially, all of profits you make on one leg will offset the losses on the other leg, but if the move is big enough, the profitable side of the spread will increase in value as the non-profitable side goes OTM and/or the delta drops compared to the profitable leg as price moves away from the strike price

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  #26 (permalink)
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It's not a matter of 'agreeing' about an ITM strangle versus an OTM. Synthetically, they're the same trade. Mathematically they're the same.

Assume stock is at $100. Buying the 95 put, 105 call strangle for $1 is the same as buying the 95 call, 105 put (ITM) strangle for $11.

That's because the ITM strangle = the OTM strangle + the difference in the strikes. Another way of saying this is that by buying the ITM strangle, you're simply buying the OTM strangle and buying the $10 box. Both of these strangles have the same risk, reward, break even points, and greeks.

The only difference in real life is that you'll get better prices by trading the OTM options.

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Greg Loehr View Post
It's not a matter of 'agreeing' about an ITM strangle versus an OTM. Synthetically, they're the same trade. Mathematically they're the same.

Assume stock is at $100. Buying the 95 put, 105 call strangle for $1 is the same as buying the 95 call, 105 put (ITM) strangle for $11.

That's because the ITM strangle = the OTM strangle + the difference in the strikes. Another way of saying this is that by buying the ITM strangle, you're simply buying the OTM strangle and buying the $10 box. Both of these strangles have the same risk, reward, break even points, and greeks.

The only difference in real life is that you'll get better prices by trading the OTM options.

You keep saying that the risk/reward is the same, but losing $0.5 on a $1 investment is not the same as losing $0.5 on a $10 investment. The risk is substantially lower in an ITM strangle than an OTM strangle compared to initial investment, and the reward is substantially lower as well relative to initial investment as well.

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  #28 (permalink)
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The $10 is not at risk. The minimum value of the trade in this example is $10 regardless of what the stock does. So you're putting $10 into the trade, the $10 does nothing for you, and then you get the $10 back.

If the point is to simply raise the capital level of the trade so that the risk looks smaller, without adding any benefit to the trade, then there are plenty of things you can do. But there'd be no reason to do it.

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Greg Loehr View Post
The $10 is not at risk. The minimum value of the trade in this example is $10 regardless of what the stock does. So you're putting $10 into the trade, the $10 does nothing for you, and then you get the $10 back.

If the point is to simply raise the capital level of the trade so that the risk looks smaller, without adding any benefit to the trade, then there are plenty of things you can do. But there'd be no reason to do it.

If you invested the $11 in the OTM strangle instead of the ITM for $11, you will raise your risk substantially. Therefore, yes, raising capital to decrease risk is a benefit of the trade.

However, also, going ITM on a long strangle would lower your position's overall vega risk, so you can use an ITM strangle to cancel out a high IV if you are late to the party and want to still participate in an Earnings Report trade, biotech study results, etc.

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  #30 (permalink)
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The vega of an ITM call is the same as the OTM put with the same strike, and vice versa. There's no benefit to an ITM strangle.

As for trading an ITM strangle for the sole purpose of raising the capital requirement, that makes absolutely no sense. What you can do is add another ITM strangle, with options so deep ITM that they have a delta of 100, and that way you'll have a VERY expensive trade (that doesn't do anything) and your percentage at risk will drop dramatically.

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Ok, we clearly aren't budging on our positions. I really can't comprehend how decreasing risk relative to investment size is not a good thing. Why do you think so many people invest in risk-free treasuries. There are risk averse traders who can participate in a non directional trade without potentially losing their head

I think I will finish my involvement in this discussion with the rational and reasoning behind ITM strangles as written in 'Options as a Strategic Investment' by Larry McMillan




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  #32 (permalink)
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Right! The question is really amount the amount of money at risk. Putting $10 into a trade, knowing that you can't lose the $10, and that the $10 isn't going to make you any money either, doesn't make it a better trade. It just makes it a more expensive trade.

So take your maximum dollar risk (not cost) from the ITM strangle, and put that same amount of risk into the OTM strangle. Take the $10 you're NOT putting into the ITM strangle and either stuff it in a mattress, buy a bond, or put it into other trades. Either way, the trades risk the same in theory, but in the real world the OTM strangle is much more likely to give you better entry and exit prices.

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