A Strategy for the Rest of Earnings

By the end of Thursday, I found myself in all the names I had mentioned during the day. I kept the trades very small across the board and still managed to tweet out the additional late ideas for LinkedIn (LNKD) and Coinstar (CSTR) well before the close, but there has been a pattern emerging on many of these high-flyer, high-beta, or high-short-interest names. Anyone who trades options around earnings is aware of the implied volatility implosion that occurs after the earnings regardless of the move. This isn't new. But the advent of weekly options is still fairly new, which has added additional room on the playing field for different approaches and strategies. It has also added to IV implosion risk for those getting long options in front of earnings. Earnings from last night and into early next week have the benefit of this weekly type of feel since monthly options expire very early this month on the 15th. Although I will take directional trades, I am finding more preference in the IV implosion trades, but approaching them in a manner that defines risk. In other words, I don't want to outright sell the options and hold a naked call or naked put or both, like selling short a strangle. A huge move there can be killers, so I want to try to limit or eliminate the high-risk portion of the trade. I want to try and limit the risk associated with no move or a very small move when a big move is priced into options, such as the move we saw in Amazon (AMZN). A great case in point is OpenTable (OPEN). The options market was looking for a move around 10% on the stock, or $5. There has been almost no movement today. I expected the weakness we had seen in the charts to continue, but we really haven't seen that either. I took a combination put position on this thesis, which included being long March and February $50 puts and as well as February $45 puts; however, I shorted three February $47.5 puts against these puts to create a long 1 by long 1 by short 3 by long 1 model. Even with the stock higher this morning, granted it's not by much, but even with it higher and the implied volatility on the stock some 37% lower, the put combination has held its value. The key here was the March implied volatility on the options was very close to the historic IV of the stock while the February options were nearly three times the historical IV. This has been a key lately. Find the long core of the combination position in the options that are trading very near historic IV levels but are also close enough to expiration that the delta remains high enough to benefit from a move in the stock while theta (time decay) is still low or reasonable. Then, as a trade, I will look to short the out-of-the-money call or puts or spreads against the long position. My focus is harvesting the IV implosion from the short front weekly or front month options, but leaving enough room so that a decent size move won't destroy the trade. It is easy to say, but hard to do. For me, I want to place those short positions around the targeted move of the front-month straddle while taking into account the technical picture. For instance, OPEN front-month options were looking for a move around $5, so with the stock around $50, I wanted my short position to be below $50. Ideally, I might look at shorting the $45 puts there, but the stock had been down hard four straight days prior to the announcement. Plus, the chart showed support in the $46 to $48 area, so structuring a trade that was still profitable at $45 but still held to the levels shown on my earnings chart led me to conclude the $47.50 put short would be optimal for my particular trade thesis. I realize this isn't simple, but it is also why I will only look to trade one to four names on earnings and no more. Furthermore, it is another reason why I close or hedge many of the trades quickly after placing them. While the Volatility Index remains low, I believe this is the best approach for the remainder of this earnings season, and I believe it will continue into next season as well.

A Strategy for the Rest of Earnings

I believe it will work into next season as well.

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