I am usually not a big fan of straddles into earnings. There needs to be a big move. The implied volatility implosion sucks away premium. I also really don't like trading banks into earnings. First, their earnings read like foreign instructions for a VCR. Second, the moves are generally pretty tame, so a straddle seems counterintuitive. However, this is exactly what I am doing.
I am looking to long the Oct. 24 $40 straddles on U.S. Bancorp (USB), as well as crisscross-strangles-long the $39.50 calls and $40.50 calls, which expire this week. Next week's options could be used as well, but I lean towards short-term expiration. The straddles are pricing in a move around 2%, and while this seems low, it is in line with historical closing levels. In fact, heading into Friday, I wouldn't expect a move above 3.5%. The stock has only closed the week with a move greater than 2% half the time. Why straddle?
The risk-reward is actually the most compelling case, even after knowing the stock probably only has a 50% chance to close the week with a greater-than-2% move. Eight times straight, it has not closed with more than a 2% move the day after earnings. Those sound like reasons not to buy a straddle, but what we haven't discussed is the intraday maximum move over the last eight reports.
The stock has moved more than 2% intraday from the pre-earnings closing price for seven times out of eight. The mean maximum move is around 2.41%, which would give a trader a chance to grab about a 20% return on a straddle. While only half of the Friday closings at reporting times have seen moves greater than 2%, only two of the moves have been 1.25% or less. We've seen six of eight weekly closes at 1.85% or greater, so the odds of losing a majority of the straddle are low.
Post-closing, look to follow the trend with a trade on the stock or shorting vertical spreads. The stock has only reversed course from its post-earnings close in one of the last eight weeks at times of earnings reports. If using shares, the reversal would have caused a loss of 1.4% on the week, but there would have been a gain of above 3% once as well as gains of over 1% on three other occasions. For those who don't want to look at a pre-earnings trade, this is the post-earnings trade I would pursue.
As far as the earnings trade goes, I plan to wait until just before the close to enter it.