Wednesday, July 22, 2009

Earnings Intuition

Although the VIX is quickly coming in line with recent realized volatility (VIX at 23 vs. SPX 30 day HV at 22), there are still a few individual stocks that have seen their options implied volatility ramp up, or at least trade at a notable premium to HV, going into earnings. As we move further into the heart of earnings season it's becoming easier to find potential candidates ripe for short volatility plays. Tonight's earnings calendar is no exception- as I've found a few stocks that are worth looking at. Let's highlight Intuitive Surgical (ISRG).

Currently ISRG 30 day HV is sitting at 40%, while 10 day HV is at 35%. (click to enlarge)

[Source: EduTrader]
Current IV (gold line) is nestled around 60%- an obvious premium to HV. As usual, the 64k question is whether or not this higher IV is warranted. So far this earning season volatility sellers have had the upper hand and been rewarded the majority of the time (e.g. GOOG, AAPL, RIMM, APOL, etc...). Assuming that will also be the case with ISRG, let's take a look at two short vol strategies: strangle and iron condor.

[Source: IVolatility]

Short Strangle:
Short Aug 140 put @ $1.90
Short Aug 210 Call @ $1.20
Max Reward = $3.12
Max Risk = Unlimited

By shorting an OTM call and put, we're essentially betting that despite the earnings announcement and the gap that generally ensues, we still believe ISRG will stay between $210 and $140. Although 210 and 140 are the short strikes, technically the breakevens for the trade are $213.12 and $136.88

[Source: EduTrader]

To those that are uncomfortable with the theoretical unlimited risk inherent with short strangles, as well as the larger margin requirement, you may consider an iron condor instead.

Iron Condor
Short 140-130 put spread @ $1.10
Short 200-210 call spread @ $1.00
Net credit $2.10
Max Risk: $7.90

[Source: EduTrader]
I lowered the short call strike to 200 on the call spread versus 210 in the short strangle. As you can see the iron condor affords less net credit, but also much less risk. In addition to ISRG, Chipotle Mexican Grill Inc (CMG) and F5 Networks Inc. (FFIV) also have options with a notable difference between IV and HV.


3percenter said...

Love the IV crush! I got into CMG this morning, an AUG 75/100 short strangle for a $2.25 credit.

3percenter said...

I wanted in on the ISRG Aug 135/210 for a $2.2 credit but alas, no more bp! Have to be content paper trading it for now.

Tyler Craig said...


Glad you've been seeing success. AAPL worked nicely as well had you played it. Keep up the good work!

aesus said...


How you feeling about your RUT spread you put on earlier this month?

aesus said...


I have a RUT spread on also. din't want you tho think I was poking fun at you.

3percenter said...

Good thing I didn't get into the ISRG 135/210 that I wanted. Gapped up almost thirty points this morning!

3percenter said...

Alot of my paper short strangles are not working out very well, since almost everything has been spiking up into the call side. What can you do in that case?

Tyler Craig said...


ISRG is a supreme example why money & trade management crucial- Just b/c a trader may win 5 out of 6 short strangles doesn't mean they're going to be profitable. Like any other trade nothing works 100% of the time.

The iron condor would have saved your bacon had you entered it instead of a short strangle-

As far as your short calls not working out great- join the club:) Nothing bearish works in an environment where you go up 2 weeks straight. I typically close out any short puts or calls when the delta reaches .35 or higher to minimize the loss and prevent myself from getting boot stomped. (Delta is around .15 or lower when I sell.)

Tyler Craig said...


I've got a few techniques I use to exit call spreads that run amiss:
1. Exit when underlying breaks resistance (for RUT that would have been 520 or 535)
2. Exit when I lose 30% of max risk
3. Exit when underlying reaches short strike price of call spread
4. Roll further OTM if desired

In this instance had I used technique 1,2, or 4 I would have already taken action to exit or roll-

aesus said...


I am going to cover on any pullback and then rewrite out to Sept. I still have significant premium left so I can rewrite with an excellent chance of profits with writing further month out.


Anonymous said...

An insightfull post. Will definitely help.

Karim - Mind Power

Tyler Craig said...

Thanks Karim-