Earnings season for the fourth quarter of 2011 is quickly approaching an end, which can offer you hefty returns if you play your options cards correctly. If you want to further increase the profits you may receive in buying options, you may consider option straddling.
Option straddling entails buying a put and a call for a particular stock. The expiration date and striking price are the same. This method can help you to hedge the risk over whether or not the stock will be higher or lower than the striking price at the time of the expiration date.
Even better is to have long positions in your call and put options, which can maximize the potential that the straddle will have large profits even if the underlying stock price tanks.
One of the reasons options straddling is so popular among investors during earnings seasons is because a company's earnings announcement can create volatility in the market. If the company beats analysts' estimates, the company's stock may enjoy gains as investors flock to it to take advantage of the company's growth. On that same note, if a company's earnings report doesn't beat analysts' estimates, the stock takes a hit as investors flee from it.
And in another common scenario, the stock may beat revenue expectations, but still fall short of other expectations, causing its shares to decline. Let's take a look at SodaStream International (NASDAQ:SODA), for example. Many investors were anxiously awaiting the drink machine maker's fourth quarter returns for 2011 in February because of the strong sales the company had in December. Many stores couldn't keep the device on their shelves as Christmas shoppers snapped them up.
Naturally, many believed that those sales would be strong enough to boost the company's overall sales. Not so fast. Instead, when the company released its earnings report, its numbers showed that unit sales had fallen short of analysts' forecasts. Its share fell roughly 16% the morning of this announcement. This despite the report showing its revenues, roughly $86 million, were above the $76 million that was expected. Buyers who were familiar with the company's growth anticipated SODA having a strong earnings report, which put them at an advantage.
Investors who bought straddle options ahead of SODA's fourth quarter earnings release report had the peace of mind in knowing that they had hedged against how the stock would be affected. The key to straddling a stock is the price of the stock moving enough for a profit to be generated. Investors benefit from the call option they purchased if the price of the stock goes up. They benefit from the put option they purchase if the stock's price goes down.
The company's next earnings report release date is May 17. It was trading around $35 at the time of writing, and had a call strike of $35. The call bid was $.70, and its net debit was $33.86. Its next options expiration date is July 12, while its next earnings release date is May 17.
Now let's take a look at a stock that has an upcoming earnings release report. Youku Inc. American Depositary (NYSE:YOKU). At the time of writing, it was trading around $25. The operator of Internet television in China is set to release its earnings report on March 14. Its strike expiration date is March 16. Its call strike is $25. The company's return, if flat, is 6%. Its annualized return is 274%. It saw an uptick in the number of its options traders on the Friday before it announced its fourth quarter earnings.
Investors willing to gamble on how earnings reports may affect the company's stock see options straddling as carrying more benefits than risks. Puts give you the right to sell your shares at the strike price. Call options give you the right to buy shares at the strike price.
When considering buying straddle options, keep in mind that you could lose much, if not all, of your money if the underlying stock is trading at the strike price on the expiration date. Because straddle options involve as much guess work as they do homework, you should stay abreast of information that could affect the underlying stocks you are considering.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.