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David Jay
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Initially David trained as a medical doctor but since then left the profession to pursue his passion in the financial markets. Currently David is a full time options trader and entrepreneur and writes a blog about his trading insights at blog.theoptionstradingcourse.com.
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The Options Trading Course
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The Options Trading Course Blog
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  • Trading Earnings: Williams-Sonoma Earnings Announcement Trade
    Trading earnings with options can be extremely profitable.  It's possible to take advantage of the drop in volatility that occurs after the earnings announcement.  By selling options you can sell options at inflated prices with high volatility and hopefully buy the options back the next day for a low price.

    I've written a detailed description of a method for trading earnings announcements. Williams-Sonoma (NYSE:WSM) provides a great potential earnings trade using options.  According to the earnings.com earnings calendar WSM's earnings release will be tomorrow morning.  Currently WSM is trading at $30.03.

    WSM options chain

    Looking at the option chain above for WSM you can see that the september options have an extremely inflated implied volatility at 73%.  Compare this to the further out months where the volatility is around 50%.  I've analysed the volatility drop following earnings for WSM.  This analysis shows that WSM exhibits a volatility crash after the earnings announcement.

    The key to making successful earnings trade is careful risk management based on a detailed analysis of historical earnings data.

    WSM price change following earnings announcements in standard deviations

    The graph above shows the price changes for WSM in number of standard deviations following earnings for the last 5 years.  The blue bars indicate close to close changes, the red is close to open data and the green is the intraday open to close data.  The left side of the x-axis is the nearest previous earnings release and the right side is the last earnings announcement analysed (24/05/2006).   Currently one standard deviation in dollars for WSM is equivalent to $1.09. 

    By looking at the close to open data you can see that apart from an outlier in 08/2006 the maximal range is from -3 standard deviations to +3.5 standard deviations.  Taking the current dollar value of one standard deviation, the maximal expected price range after the earnings announcement will be between $26.76 and $33.85.

    I expect the volatility after the earnings announcement to equalize with the volatiity of the further out months.  This will mean a drop of about 20% in implied volatility. I'll select a safer drop of 15% for my analysis.

    WSM earnings trade profit and loss graph

    Above is the profit and loss graph for this earnings trade.  The white line is the theoretical value of my position tomorrow after the earnings announcement taking into account a 15% volatility drop.  The options I decided to sell is a SEP 27 strike put for $1.00 and a SEP 34 strike call for $0.70.

    You can see that the profit range for my trade almost fits the maximal expected range for the earnings trade that I analysed previously.  The profit range is extremely wide.  Since the average close to open price change is 1.8 standard deviation, I can reasonably expect to make a profit of 20% on the initial credit of my position and the chance for loss is very small.

    When selling options it's important to consider disaster scenarios that don't fit the historical model.  Even taking into account an unexpected 15% price movement to either side the potential loss fits well within the 5% of total trading capital that I'm willing to risk on any trade.  

    You can follow my blog at The Options Trading Course to see more info on trading earnings announcements with options.

    I've found this to be one of the most consistently profitable and safe trades out of any potential stock or option trade.

    Disclosure:  I opened a short strangle on WSM selling September options.  I sold $27 strike put for $1.00 and a $34 strike call for $0.70.

     
    Aug 22 4:51 PM | Link | 1 Comment
  • Interesting Option Trading Strategy: Short PCLN strangle over weekend
    The recent market crash has elevated volatility throughout the markets and this has brought on both opportunity and peril to investors.  

    The initial period of the market correction was highly profitable for long straddle trading, however now that the market has digested the news of the S&P credit downgrade of the United States, the volatility will probably tend to trend lower.

    With this in mind I've opened a short strangle on PCLN just before the close today, Friday.  I aim to benefit from the large time decay over the last weekend prior to expiration and close the position on Monday morning.

    In general short strangles can be quite a risky trade due to the large loss potential.
    However following detailed historical analysis I've quantified expected price movements over the weekend.



    From the graph above you can see that the close to open price change over the weekend is only 0.33 standard deviations with one standard deviation currently 17 points.  



    From the graph above you can see that only 4% of movements are over 1 standard deviation on Mondays in 2011 (I changed the value in excel).  The rest of the value are for movements greater than 0.5 standard deviations and you can see that also for 2010 Monday tended to be much less volatile for Close to Open movements.  This indicates that PCLN is relatively insensitive to weekend events.

    If I take a conservative figure of a 0.9 standard deviation movement over the weekend, this will mean that on Monday PCLN should trade between 487.37 and 518.13.  Currently PCLN is trading at $503.  This is equivalent to a movement of 3.1% in either direction.  

    I shorted a PCLN straddle for $20.55.  This involves selling a 500 put option and selling a 505 call option. With a theta of 175, this means that the value of PCLN options will be eroded by time decay by a figure of $1.75 each day.  On Monday, with PCLN trading at the same price, the straddle should be worth $15.69.

      


    The graph above shows the profit and loss graph for this options trading strategy.  You can see that my profit range will be between $485 and $519 for this short strangle trade.  This is well within my very stringent range requirement of between $487 and $518 and leaves me with a decent margin of safety.  

    This option trade is obviously highly sensitive to volatility with a vega of -46.  If the markets continue to calm and volatility decreases this will aid my position and increase the potential profit. Conversely, if volatility picks ups this will negatively impact my trade.

    Please feel free to comment about this trade and add any insights or ask questions.

    You can learn more about option strategies at my blog on The Options Trading Course.
    Aug 12 6:09 PM | Link | 6 Comments
  • Falling Volatility - Profiting from market calm using RUT
    The markets went haywire over the last couple of weeks, with a real stock market crash in the making.

    Now we're experiencing a recovery with falling volatility levels on most stocks and indices and it seems that some semblence of calm is pervading the markets.

    I've opened an options trading strategy to take advantage of the tendency for volatility to decline.  The good thing about the trade is that if i'm wrong, the potential loss is limited, since I'll be using the iron condor strategy.

    Today I've opened an iron condor on RUT.  The reason for using RUT is that the volatility on RUT has been pumped up the most out of all the indices and it is relatively liquid which is important for options trading.

    The IV (implied volatility) for the August expiry series is 58.9% and the RVX (the volatility index on the Russell 2000, similar to the VIX for the SPY) is at 47.4.

    I sold a bull vertical put spread 660/650 for 2.55 (IV ~60%) and a bear vertical call spread 705/715 for 3.35 (IV ~46%).  

    RUT Iron Condor - at open of trade

    The maximum amount at risk is $4100 and max profit at expiration is $5900, within a range of 655 to 710.  However I don't plan to keep the trade open until expiration.

    My aim is to close the trade on Monday, realizing the time decay of the weekend and hopefully also a decrease in volatility.  

    My vega currently is -70 and theta is 234.  With time decay alone my profit range on Monday will be between 644 to 705 with the RUT trading at 683 currently.  With an estimated volatility decrease by 10%, the max profit should be $2,300.  

    RUT iron condor expected P&L on Monday

    If at anytime before this I get to even half the max profit I will close the trade.

    You can follow my blog at The Options Trading Course to get constant updates about my trades and learn more about option trading.
    Aug 11 1:08 PM | Link | Comment!
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