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A strategy for GOOG on earnings released before expiration

 
" I hate quotations. Tell me what  you know"
      Ralph Waldo Emerson 

It is a fact that the market makers have to keep IV at high levels going into earnings no matter if options expiration is just around the corner , simply  because they don't want to get caught out on big move , therefore when the announcement is made IV collapses
 
This is the logic behind the strategy
Actually there are 2 strategies 

The edge is by betting that the move will be less than the IV predicts, hence shorting Vega and the skew are the foundation of the play
Important to note that the inbuilt edge is that the market makers in order to protect themselves they overprice options , otherwise they would be losing a lot every time as earnings season is on
In other words they have to sell high priced straddles and strangles 
Therefore the odds benefit of those selling volatility
What about a huge move ?
Could you expect to lose much ?
Maybe, but also we can work out  by  putting  the odds in our favor 


One  is a Broken Wing Butterfly , which is like a regular butterfly except for having one of the spreads larger in size 

A normal butterfly is basically 2 spreads  ( Long and Short) ,both same size 

GOOG earnings will be released on Jan. 19 after the market closes 
In the next  example  I will use today's quotes ,bearing in mind that if the strategy is to be used , Jan. 19  quotes  should be used 

As of this writing GOOG @ 625.26
A  normal  ATM  Call  butterfly would be     625 / 630 / 635 
and  a  BWB    would be   625 / 630 / 640  as you can see the short spread is 
larger

Let's  do some cost analysis 
LONG              Jan  625  Call            @  17.95         1 C
SHORT            Jan  630  Call            @  15.55         2 C
LONG              Jan  640  Call            @   11.20        1 C
NET                                                           1.95        Credit
Upside B. Even    =             636.95
Upside Max.Loss =              3.05
Max. Profit           =              6.95


GOOG  P/L   BWB   Chart




The other strategy is an Unbalanced Butterfly which basically is a hedged ratio write having more credit spreads than debit spreads
I will use 625 , 630, and 635 strikes 

1   LONG  625 / 630   Spread
2   SHORT 630 / 635  Spreads

or    1:3:2  ratio 

LONG            Jan   625 Calls           @   17.95        1 C
SHORT          Jan   630 Calls           @   15.55        3 C
LONG            Jan   635 Calls            @   13.3         2 C 
NET                                                           2.10        Credit 
Upside B. Even  =               633.55
Upside Max. Loss =              2.90
Max. Profit    =                    7.10






Important to mention  that both trades  are done for a credit 


Because as we expect the stock to move after earnings are released , we are betting only on one side so it is important to place them for a credit or at least for even money in that way if the stock moves the other way (against ) we still be making a profit by collecting the initial  credit ! 

The other important things to do in the analysis is to ensure the breakeven to be outside of the 1 std. deviation expected move at expiration 
This will make the trade  higher in  probability of success 
Also I would recommend  not to trade if the Risk Reward  ratio is higher than  1


 
Next time I will discuss Standard deviation     

Until then 
Good luck !



 










Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.