Thursday, July 2, 2009

APOL follow up

Monday's post contained an overview of two potential plays on APOL earnings. Let's see they played out.
Short Strangle:
Sell July 60 put @ $1.05
Sell July 75 call @ $1.10
Net Credit = $2.25

Because of the 8% gap up, the short July 60 puts could have been closed out around $.10 Tuesday morning resulting in a $.95 gain. And what may be surprising to some, despite the up gap the 75 call didn't even rise in value. Had you held it until today, you could have closed it out around $.30, resulting in a $.70 gain. All told, the short strangle would have profited about $1.65 in a few days. Not too shabby indeed! Once again, the primary dynamic that goes into making a short strangle profit is the huge volatility crush that occurs post earnings. We highlighted this with RIMM's earnings, but let's take a look at the APOL vol chart.

Remember, the gold line is implied volatility, the blue line is 30 day historical volatility. Pre-earnings the implied volatility was perched around 55%, quite a hefty premium to the 30 day HV of 40%. As usual, IV experienced a precipitous fall from 55% to about 40% post earnings. This vol crush is the dynamic that should take the most credit for producing our profitable trade. With the vol crush in the spotlight it should make sense why sometimes a stock undergoes an 8% gap up and OTM options (e.g. 75 call) not only don't increase in value, but often decrease in value. That's generally why it's a suckers bet to buy OTM options into an earnings announcement. They're typically so juiced up on IV that the expected gap is already baked in the cake.

Iron Condor:
Sell July 60-55 put spread @ $.77
Sell July 75-80 call spread @ .65
Net Credit = $142

The condor had a similar outcome to the short strangle. Tuesday morning you could have closed out the bull puts immediately at $.10, locking in a $.67 gain. Had you waited until today to close the call spreads, you would have been able to exit around $.30, locking in a $.35 gain on the call spread. All told that's a net profit of $1.02. Considering the margin requirement was $3.82, that's a 26% return in a few days.

Now before you get too excited to go running out to get doped up on copious amounts of condors & strangles into earnings, keep in mind that there are circumstances where the stock gaps much more than expected. GOOG April 2008 earnings comes to mind- it resulted in almost a $100 gap. That is precisely why good money management is paramount. If you're properly spread out over multiple trades, the occasional extreme gap shouldn't kill you. So don't overdose (e.g. risk too much capital) in this type of trade. In addition, some options implied volatility doesn't ramp up as much into earnings as others, so not every announcement presents a playable opportunity.

18 comments:

aesus said...

Tyler,

Do you use a specific set of parameters on Ivol to scan for candidates for post earnings vol collapse? IF so, would you mind sharing?
Thanks, love the site by the way. Just facts - no ego.

Tyler Craig said...

Aesus,

My method for searching for candidates is quite unsophisticated. I merely stalk the earnings calendar for higher volume stocks with liquid options that are reporting earnings. Then
1. I'll glance at their IV charts on ivolatility.com to see if they seem to be pumped up. I don't really have a minimum threshold. RIMM and APOL are both great examples of what I'd be looking for though.
2. I'll take a look at the next month or two of options to see if there's enough premium to justify throwing on a short strangle of iron condor.
You could also throw on the short strangles post earnings if you wanted to avoid the drama of the gap. It would require using 2 or 3 month options to get enough premium on far OTM options though.

Glad you're liking the site- tell your friends about it. And feel free to pipe in with comments down the road if you have them.

1option said...

Great post Tyler! I have always ran about as far away from earnings as possible in the past! But you are bringing things to light, which means I may test the waters one of these times.
Is there anyone with earnings next week that you've got your eye on??
Thanks!

Tyler Craig said...

1option,

AA and CVX are the big dogs reporting next week. AA is too cheap in my opinion for this type of play. CVX may present an opportunity, right now IV not really pumped up that much so we'll have to see if anything changes between now and next Thursday. Other than those two, I don't see anything too compelling...

aesus said...

Tyler,

I would tell friends if I had any. haha. I frequent a couple of blogs but yours is the one of the few where the view is entirely empirical. I am a pure probability trader and mostly a credit seller. I trade verticals, ICs, and naked puts as well as some select covered calls. I am registered so my comments in the public forum will be limited due to regulatory limitations. Feel free to drop me a line privately at aesus at comcast dot net if you any other comments.
Thanks

Charley240 said...

Hi Tyler,

I really like your bolg. What would the outcome have been if the stock had gapped down instead of up?

Clive

Tyler Craig said...

Aesus,

Sounds good-

Tyler Craig said...

Clive,

Good question- sorry it's taken so long to reply. Had the market gapped down, the outcome could have been almost identical. It all depends on how far it gapped.

B/c we had on a 60-55 put spread we wouldn't have wanted it to gap below $60. Let's assume it gapped down to say $62. Well the call spreads could have been closed out fairly quickly at almost max gain. You could have either closed the put spreads out quickly (hopefully at a small gain) or held on to see if more value would erode out of the put spread due to time decay or a bounce in the stock price.

Had the stock gapped down more, or traded lower after the gap down to $62, the put spreads may have needed to have been closed at a loss.

aesus said...

I am using Finviz to screen for the weeks earnings and then Ivol to look at charts. Anyone have a better way?

Anonymous said...

Candidates for this week:
RT
FDO
PGR

What say you Tyler?

Tyler Craig said...

Anon,

I'd rather not make specific recommendations as to which stocks are prime candidates and which aren't. I trust that based on the examples I've given, you can deduce what an ideal candidate would be.

There's also personal preference. I prefer to play higher priced stocks- as there are more strikes to choose from with adequate premium. I think it's tough to find great setups with stocks under $20 or so. Which would obviously knock out RT and PGR for me personally.

aesus said...

Tyler,
Sorry, I accidentally posted as anon.
True on under $20 but, there are exceptions, as we both know. Not seeing enough premium in either of the three right now. Will wait.
Aesus

Tim Justice said...

Tyler,

Where is my love!?!?

Honest question....did I not put you on the APOL trade?

Tim

Tyler Craig said...

Tim-

LOL- I got plenty of love. Yeah you did put APOL on the map for me and from a broader perspective you put the whole short strangle approach in perspective. KUDOS to you!

Tyler-

Tim Justice said...

That's all I needed....now I don't have to bring pain down upon you physically....just on the golf course~!

Tim

aesus said...

Tyler,
Here's a general ?. When faced with options that are expiring right around the same time as earnings are being released, do you go front month or the net month out?
Just curious.
aesus

Tyler Craig said...

Aesus,

Very good question. I'll do a blog post on it with a more comprehensive answer. It's really just a matter of trade-offs. Do you go for the higher time decay, higher gamma (and lower credit) of the front month. Or the lower time decay, lower gamma (and higher credit) of the 2nd month. I'm not sure if either one has a definitive edge-

If the stock gaps way too much, I'd prefer to be using 2nd month options, if it doesn't gap as much as expected I'd prefer to have been using the front month. Just need to make sure there's enough premium in front month to justify it.

Mike said...

What I think that there is also personal preference. I prefer to play higher priced stocks- as there are more strikes to choose from with appropriate premium.
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