Long Straddle/Strangle Example for Earnings Season in this Market Environment

ErnestZerennerStraddle/Strangle Example

Many of you know, I’ve been trading for over 50 years. Over that time, I’ve come to recognize market conditions that coincide with trading opportunities. Here are some of the conditions that led me to one of my latest trades… and an example trade you might love!

The last two weeks of October is when most companies announce third quarter earnings. This particular October, following several years of bullish market conditions, stocks appear to be topping and consolidating. This topping process seems to be accompanied with increased volatility.

In this mix of market environments, stocks with earnings disappointments are getting hit particularly hard while other stocks having positive surprises and large upward moves. This seemed to be an opportunity to speculate with an option strategy that might take advantage of these wide swings in stock price due to surprise earnings announcements.

P-t_graphThe long strangle is an option strategy that can take advantage of a wide swing in stock price in either direction. I used a strangle rather than a straddle because the premiums are generally cheaper and the position is more leveraged. As you may recall a long strangle consists of the purchase of an out of the money (OTM) call and put. The further OTM the call and put are, the lower the combined premium to buy into the position, but the more the stock must move to realize a profit. One side or the other will probably go worthless and the other side has to move in stock price enough to pay for both the put and the call for the position to become profitable.

I set up a search on PowerOptions looking for impending earnings opportunities. Here are the search parameters I used:

Option Parameters:
1 strike out of the money (OTM) for both the call and the put. If the expectation is for a negative earnings report and you want to emphasize it you could lower the cost of the call by going more OTM i.e. 2 or 3 strikes. But in this case I had no expectation of a bullish or bearish move one way or the other, but a big move up or down.
Implied Volatility (IV) was set to greater than 0.45 (>45%). Since we needed a big move to pay for the net debit of the option purchase, we need a stock that will make a wide move. The IV was also used to sort the resulting search list from highest to lowest.

The expiration date for the options was set beyond the earnings announcement time frame. I used 30 to 100 days out in time.

Open Interest was set to greater than zero to assure some liquidity. It is good not to be the only trader in the market for your particular options.

Net debit was set to less than 10 points to limit the cost to $1,000 for each position purchased. This would also limit the results to stocks under about $100 per share.

Technical Parameters:
Stock price % of 52 week range was set to greater than 50 (50%). We wanted stocks closer to their highs rather than the lows because any disappointment would would have the potential for greater price movement.

search_settingsFundamental Parameters:
We looked for stocks that would have an earnings announcement between now and 3 weeks out in time.

Stock price was set to greater than 20. Higher price stocks will generally have a larger price movement potential.

A complete summary of the screening parameters is pictured here.

Running this screen on October 12th resulted in a list of 7 opportunities. The first stock in the screened results list that I chose was Pandora Media Inc. (P) at $20.50 per share. Pandora is a music streaming service company that had a recent IPO. The long strangle position was:

P @ $20.50 with third quarter earnings due in 10 days
Buy to open: 20-Nov 21 Call @ $1.64
Buy to open: 20-Nov 20 Put @ $1.69
Net debit: $3.33
Over the subsequent 9 days the stock drifted lower toward $19 per share, but after disappointing earnings were announced (P) declined to $12.98 at the open with a range during the day of $11.50 to $13.38 and closed at $12.39. The put option had a trading price range of $4.55 to $8.10.

p_stock_chartSince the decline was so large I anticipated a rebound later in the day and sold my put option in the morning:

P @ $12.90
Sell to close Put @ $6.76
Return = 103% (6.76-3.33/3.33)

and this was not the best price of the day. The call is presently worthless, but I’m going to hold it just in case there is a rebound in the 26 days remaining before expiration.

As of this writing it is not clear if the call will regain any value by expiration, but it does not cost anything to hold it. For (P), both the earnings and revenue announcements were close to forecast, but the projection for next quarter had concerns about Apple as competition.

This strangle position resulted in a 100% return in 10 days. You can create screens just like this. Log on to your PowerOpt.com subscription or free trial account to make your own search.

P.S.: As mentioned earlier there were seven opportunities the resulted from the screen applied. All of those earnings announcements have now passed (10/28). We historically back tested the outcome for the other resultant stocks. It showed that (P) was the first choice with the best performance. Four of the seven positions were profitable with the average gain for all seven at +35%.

A Balanced Approach for Portfolio Success

The Conservative Barbell Strategy

We recently reviewed a book written by Nassim Taleb called “The Black Swan”. In it, the author suggests an approach for investing called the Barbell Strategy. The approach is based on the concern that unexpected market events can happen with devastating impact to our portfolios. The Black Swan is about such events that are generally unknown, unpredictable, and cannot be planned against to mitigate losses. Because they are unpredictable they cannot be avoided, we need a way to protect assets as best we can against these unforeseen events.

The Barbell strategy uses the two extremes: Ultra conservative positions at one end and highly leveraged, speculative positions at the other end of the risk range. The strategy advocates having most assets in very safe securities like treasury bills and a small portion in high risk – high reward securities like options. The Barbell image is used to show assets at the two ends of the conservative / speculative spectrum. But the Barbell is unbalanced with 90% ultra conservative and 10% speculative. The concept is to invest 90% of the portfolio in treasury bills, therefore, the portfolio is fairly insulated from unplanned events like a Black Swan. In the event of some catastrophic event only 10% of the portfolio, which is invested in the high risk-high reward investments, is exposed to a loss. The high risk-high reward portion of the portfolio provides most of the returns under normal market conditions. Continue reading

Effectively Track and Manage your Options Investments

As we approach options expiration you need tools to properly track, evaluate and manage your options positions.  All of this can be done using the Portfolio tools on PowerOptions.

You can quickly create and enter new or existing positions into the Portfolio tools. Once a position is entered you can set Alerts to be notified when profit targets are hit or when losses may need to be managed.

As you track your positions you can link to the Position Analysis tool to see your current liquidation and future expiration values as well as view various roll out opportunities for your positions.

As you are viewing potential Roll Out Opportunities you can link to the Trade Simulator tool to see the before and after profit and loss graph of your current position compared to the potential adjustment.

This video shows just how easy it is to enter positions into the Portfolio and evaluate adjustments as expiration approaches.  Enjoy, and we hope you have a profitable expiration!

5 Keys to a Successful Option Spread Trading Plan

The key is likely to first develop a trading plan for your spread positions in conjunction with the tools on PowerOptions. A trading plan may consist of:

  1. What are my goals for monthly or annual income?
  2. What exposure am I willing to risk in the market?
  3. Should I look for lower probability trades with a higher return, or higher probability trades with a lower return and higher risk vs. reward ratio?
  4. What is most important in your trade selection:
    • The underlying security?
    • Minimum option premium?
    • Volatility?
    • % Return or % Annualized Return?
    • % Probability?
    • Difference in strike prices (risk on the trade)
    • Time frame for an open position (weeklies vs. standard expiration).
  5. Detailed Exit Strategy, including what is an acceptable loss vs. management techniques in various situations.

This may sound like a lot to cover but once you map out a trading plan the pieces will fit together regarding:

  1. What criteria are most important to use in the PowerOptions search tools.
  2. What steps will you use to research and analyze the position more effectively.
  3. What alerts to set in the Profit and Loss Portfolio tool as you track your spread positions.
  4. What to look for when adjusting, rolling or closing a spread position.

The PowerOptions’ staff is available every trading day during trading hours by email and toll-free phone lines to help you get your trading plan together and get you setup with the PowerOptions tools to make your investing plan easy to implement.

Conversions Are A Riskless Options Trade

option conversionConversions, if you are able to receive a credit, are no risk options trades with a very limited reward.

One example of a conversion is:

Buy shares of SLV @ $18.73
Sell JUN 18 call @ -$ 1.08
Buy JUN 18 put @    $ 0.34

Net Debit =         $17.99
Guaranteed exit/assignment = $18.00
Guaranteed Profit =          $ 0.01

1.  Possibility for a no-risk trade
2.  Credit is received
3.  Management is not necessary
4.  Opportunities can easily be found with PowerOptions

1.  Guaranteed Profit is extremely limited
2.  After commissions limited profit might turn into a loss
3.  Due to low profit, 1,000s of shares may need to be traded which hinders the retail investor
4.  Opportunities may appear, then disappear quickly.  I found this trade on PowerOptions, but by the time I linked to the profit and loss chart the trade showed a guaranteed loss of -$0.04 due to price changes in under a minute.

Stock Insurance OR Portfolio Insurance – Revisited

With the addition of new and interesting securities to help hedge a stock portfolio, the question arises more and more: ‘Is it better to insure my stock directly or use a different hedge to insure my portfolio?’

This is a very important question which has many components to it. During a PowerOptions Open Forum Webinar on January 14th, 2014 this question was posed. The actual question was: Continue reading

MORNING UPDATE: PriceWatch Alerts for BA, TSLA, AAPL, and More…

MORNING UPDATE: PriceWatch Alerts for BA, TSLA, AAPL, and More…

February, 11 9:00 AM ET – PriceWatch Alerts for BA, ATVI, MNST,
Overview, News Leaders and Laggards, Today’s Economic Calendar,
and Index Support & Resistance Levels.

PriceWatch Alerts for BA, ATVI, MNST, TGT, YPF, TSLA, DISH, BLK,
MMM, RIG, AAPL, NPSP, GM, X, DLTR. Continue reading

Weekly Options Crash Course for Options Expirations

When the weeklies were initially offered on standard stocks, you would have only the next week out option. The new option would be released on Thursday morning prior the current weekly option expiring on Friday.

Continue reading

Filter for MACD added to the PowerOptions Search

A new filter for MACD has been added to the PowerOptions Search tool for all strategies! This new filter (located in the Technicals tab) will allow you to search for stocks where the MACD is above or below the Signal Line and by how many days. You will also be able to screen for stocks where the MACD and Signal Line are above or below the Zero line. This filter will allow you to better screen for stocks with positive or negative momentum.

Timing Investments when Stock Price Crosses a Moving Average

Timing your entry into a position using options is very important because time premium is continually eroding from the position.  Ideally we want to enter a bullish position just as the stock is about to move up.  It is not possible to know in advance when the move will occur, but we can get an early indicator once the move has started.  There are several tools available to help the investor pick the best time to enter a position.  One such tool, which has been recently added to the PowerOptions screener, is the crossing of a stock price above a moving average such as a 20 or 50 day moving average.  Another form of this tool is to use the crossing of the 20 day moving average over the 50 day moving average as a bullish trigger.

Investors will scan charts looking for this type of crossing to trigger a buying opportunity.  They also look for confirming volume as the crossing takes place, however, this effort can be very time consuming.  Using the PowerOptions screener an investor can scan the entire market very quickly to find a first-time stock price crossing of a moving average.  The parameter scanning form in PowerOptions to capture the moving average crossing is very simple to use: Continue reading