John Jagerson

Trading Option Straddles During Earnings Releases: Part 2

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See Part 1.

Trading straddles during an earnings announcement ensures a high likelihood for volatility and inflated option prices.

These are the offsetting opportunities and risks of the earnings straddle. If the stock moves a lot, then the straddle will likely profit; however, if the stock doesn't move enough, the deflation in option prices following the announcement will create a loss.

These offsetting risks and opportunities are not surprising and most short-term straddle traders anticipate more losing trades than winning ones. Long-term profitability rests on those outlier earnings releases in which the stock moves dramatically and large profits can be accumulated.

In the case study from the last article, we illustrated a straddle on Google (GOOG) that cost $45 per share or $4,500 total. If we assume that the position was held until expiration, that means that the stock would have to move at least $45 per share up or down to reach breakeven.

Calculating the expiration breakeven is a reasonable way to estimate how far the stock needs to move to compensate for the deflation in the option prices following an earnings announcement. In this case, the stock did not move far enough to make the trade profitable, and any potential straddle traders are now faced with two alternatives for exiting the position.

1. Selling to exit the straddle immediately

Option prices have declined the day after the earnings announcement and currently the 390 calls are worth $13.30 per share and the 390 puts are worth $20 per share. The total value of the straddle is $33.30 per share or $3,330 dollars per straddle. Because this is an actively traded stock, there should be no problems selling to exit the straddle and move on to a new opportunity.