An Earnings trade in AUXL – Earnings 5/3/10 BMO

Posted by: Admin: "The Vol_Trader"  //  Category: Earnings Trades, Volatility Trades

I’ve been unusually busy in my ‘real job’ as a physician.  Sorry for not posting in a week…

I spent a little while scanning the LiveVol Pro earnings calendar and found a stock that has performed quite well as far as Vol Crush after earnings.  Looking at the ‘Earnings and Divis’ tab, AUXL has made money five out the past six earnings releases by selling the back month straddle.  See the charts below: (CLICK all pictures to enlarge them)

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As you can see by looking at the yellow line in the top row of charts, the $ value of the back month straddle decreased in all except the Oct 2008 earnings release.

Investigating the Oct 2008 release reveals an interesting event.  The IV did not Crush after earnings.  I’m guessing there was a ‘Vol Event’ other than earnings priced in here as this IS a Pharm company.  Also, the stock had a pretty large downward move right before earnings.  You can see in the below 2 year chart of IV that the vol did in fact, not crush at earnings.  This earnings does not seem to have these two factors to deal with from my research.

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The below Thinkorswim analyze tab is showing the sale of the front month straddle is predicting a move between 31.68 and 38.32 with the underlying currently trading at $35.99.

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Rather than sell a naked Straddle, I’m going to buy wings and sell an iron condor. Here’s the trade: All options are Jun expiry, back month.  -25 $37.50 call /+25 $40 call /-25 $32.50 put /+25 $30 put for a credit of $1.10 per condor.

The Thinkorswim P&L chart is below:  I like that the breakevens are wider than the predicted front month straddle’s move.  I like that the chart is skewed to allow for a large downside move than upside as I feel the risk is to the downside.

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I plan on taking all or partial profits immediately after earnings.  Stay tuned for results.

www.livevol.blogspot.com  is a must read if you like my blog. Also, check out www.livevol.com for their software. 

Another must read is www.option911.com . Mark Sebastian is an amazing authority on Vol Trading.

*this is not a trade recommendation.

Testing, testing, 123

Posted by: Admin: "The Vol_Trader"  //  Category: Volatility Trades

Sorry for the corny title, but I’m testing a strategy in my Thinkorswim paper-money account. I’d love some feedback and discussion of my trade logic, so please comment!

My idea is as follows:  I want to get short delta and long vega for what I think is the inevitable market crash that is coming. I’ve been saying this since the short term correction in mid July 2009, so please do not let my idea influence any of your trading decisions.  Let this be a lesson in the greeks, rather than market direction.

So, short delta and long vega, what is the first thing that comes to mind?  If you said a long put, you be correct.  The problem with naked long puts is time decay works against you.  You can only be right if the market moves down and does so right away.  If it goes down slowly you lose.  If it stays the same you lose.  If it goes up you definitely lose quickly, not only from delta but also from Vega as IV generally goes down with market rallies. 

I want to get long vega and short delta by purchasing puts.  I chose to buy OTM Jun 115 puts for $1.55 with SPY trading at $120.16, 50 contracts.  (The simple facts: These are .25 delta, so they have a close to 25% chance of expiring $0.01 ITM which of course means I lose the full $1.55.  In order to break even I need them to be $1.55 ITM or SPY at $113.45.  Any lower than that is profit.)

This is what the naked long Jun $115 put looks like at May Expiration below in the Thinkorswim analyze tab. (Not Jun Expiration, I’m going to add May options to this trade and the plan is to be out by May expiration.) At May expiration and at the current price and IV the max loss is around $7,700, and breakeven is around $117.

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In order to offset theta, I decided to sell a Jun ATM 120 Straddle 25 times. Adding the straddle actually makes the theta slightly positive (close to zero) at the current price. The naked long put has a negative theta of around $150 / day.  Now, combined long put, short twice as many straddles leaves me with risk to the upside because I’m short naked calls from the straddle.  The short puts from the straddle ore more than hedged due to twice as many long puts.  The comparison of the two trades are below.

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You can see the naked put does better if the market falls below $115 but the combined trade does better up to around $125 but this chart is not showing something, the effect of vega. 

Below is a chart of Vega on the Y axis and underlying price on the X axis.  The combined position clearly has an advantage to the upside.  It is short vega above $117.50 whereas the long put is always long vega.  Remember, as the market goes up IV generally goes down. 

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The last adjustment is to address the upside risk.  I’m net short 25 June calls.  To offset this I will buy 25 May OTM $123 calls for $0.68. Call these the cost of insurance.

Now, I have less risk to the upside than just the naked long put.  In the below chart you can see the combined position has a max loss at current IV of around $4,400. I sacrifice downside profit, but I significantly reduce risk.  Plus, If the market crashes I will be long Vega and should do really well to the downside.

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Below is a year to date chart of SPY on the top and 30 IV on the bottom from LiveVol Pro.  You can see IV is at a low of 13.81% right now.  If we have a major pull back to where we were on 2/5/2010 you can assume IV will be at least the same, but probably much higher than 23.77% that it was then.  this 10% increase translates to $1,200 profit on the combined position with Vega currently at $120. Remember from the chart of Vega, Vega increases as SPY drops too, so the profit from Vega should be much higher.

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After all this, I’m considering putting this position on in real money tomorrow in a much smaller quantity…

Remember, nothing on Voltraderblog is a trade recommendation but just an educational forum…

Bonus: Why does IV go up as the market go down and IV go down as the market goes up?  — When the market goes down longs buy puts for protection.  Remember option pricing is controlled by supply and demand. Demand goes up and the market makers having to take on more risk being short options increase prices of puts.  The only variable that is unknown in option pricing formulas is IV, therefore, as option price goes up, IV has to go up as well working backwards from option pricing formulas. 

SNDK – I took the loss…

Posted by: Admin: "The Vol_Trader"  //  Category: Earnings Trades, Volatility Trades

Chalk this trade up to a lesson learned… Don’t trade too soon.  Yes, I entered this trade too early before earnings.  Since entering this trade at $35.93 for the underlying, SNDK went up to a high this morning or $38.57 or up 7.35%. 

I was bearish on the market, and bearish on SNDK and I was WRONG.

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I closed all options today for a loss of $680. 

Like the barber says, “Next”. 

SNDK update – A trade adjustment ?

Posted by: Admin: "The Vol_Trader"  //  Category: Earnings Trades, Volatility Trades

As you can see from the below 5 minute chart of SNDK I managed to enter my trade right near the bottom yesterday at $35.93.  SNDK then rallied (with the rest of the market) up to close at $36.69, up 2.1%. 

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This puts us much closer to the upside breakeven and short much more delta going into earnings.

This morning SNDK gapped up and is currently trading up 2.25% at $37.51.

I am considering adjusting this trade to become delta neutral and short Vega, or perhaps just take a small loss and move on… BTW: yes, delta neutral, I’m thinking of giving up on the short delta position as this market seem like it’s constantly bullish.

To adjust, I will likely add an OTM call calendar spread. I’m looking at the May / Oct $39 call strike and will use enough contracts to make us delta neutral.  At the current price this will be 26 contracts.

The combined trade looks like this:

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I’ll keep you updated.

SNDK another earnings trade

Posted by: Admin: "The Vol_Trader"  //  Category: Earnings Trades, Volatility Trades

SanDisk Corp is scheduled to report earnings 4/21/10 (AMC). 

I want to get short May IV.  According to the LiveVol Pro chart seen below the front month straddle has lost value four of the past six earnings releases.  Additionally, the stock price has gapped down after earnings four of the past six releases.

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My thought process here is that I want to be short Vega and short Delta.  (SNDK is now down 4.7% and the NDX is down and I’m currently bearish in general.)

I decided to model an unbalanced short straddle with more short calls than puts.  I looked at a 2:1 short $36 ATM straddle.  Then I decided to buy some ‘wings’ for protection.  The ATM short $36 straddle is predicting a move of $4.60. SNDK is currently trading at $35.93, so the move predicted is between $31.33 and $40.53.  I decide to buy the wings at the $32 put strike and $40 call strike.  So, the trade is:  all May expiry, –20 $36 calls, –10 $36 puts, +20 $40 calls, +10 32 puts. 

I like naming my trades, so I think is can be called an ‘unbalanced iron butterfly’?

The Thinkorswim P&L chart looks like this below:

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After earnings IV should crush for all the options.  The trade is profitable under $38.10  (+ 6.04%) which is my upside mental breakeven, but a gap above here is very possible with good news.  Max loss is $3780 but with almost a whole month to go after earnings there’s little to no chance of that happening. 

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Above is the LiveVol Pro chart of Implied Volatility.  Notice the run up into earnings last quarter and again this quarter.  Last quarter IV fell from 60.9% to 50.6% or around 10%.   I modeled our trade with a drop in IV by 10% as seen below:

You can see how a one day drop in IV by 10% brings the white line up into the profit zone without the underlying moving at all in the below chart.

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I’ll provide updates on this trade going forward.  If SNDK has a big move down tomorrow prior to earnings I’ll take a partial profit, otherwise I’ll hold the whole thing into earnings after market on Wednesday…

*this is not a trade recommendation.