2 Options Strategies for Earnings Season

Examining the advantages and disadvantages of long straddles and strangles

Patrick Martin
Aug 3, 2017 at 3:24 PM
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We are in the thick of earnings season, and recent options activity on the ultra-low CBOE Volatility Index (VIX) indicates traders are expecting a volatility pop. Against this backdrop, we decided to outline two ways options traders can profit from a big stock move in either direction: the long straddle and the long strangle. Below, we will discuss the basics of a long straddle and strangle, their advantages and disadvantages, and highlight their usefulness during earnings season. 

Long Straddle

The long straddle is set up by purchasing both an at-the-money call and put at the same strike price in the same series. For example, if stock XYZ is trading at $60, you could initiate a long straddle by buying to open the September 60 call for $2.50, and simultaneously buying to open the September put for $2.50. Your maximum risk is the total premium paid: $5.00, or $500 (x 100 shares per contract), in this case.

You'd profit off such a deal if the stock exceeds $65 (strike price plus net debit), or falls beneath $55 (strike price minus net debit), by expiration. Specifically, your profit will increase the higher XYZ moves north of the upper breakeven rail by September options expiration, or the deeper XYZ sinks south of the lower breakeven rail in the options' lifetime. The worst-case scenario would be for the stock to remain stagnant, in which the maximum loss would be your initial investment. 

Conveniently, Schaeffer's Senior Qualitative Analyst Rocky White sat down and outlined some of the historically best straddle plays in the past two years. 

Long Strangle

Much like a long straddle, a long strangle allows you to profit from a big move in either direction. However, the strangle is initiated by purchasing calls and puts at different, typically near-the-money strikes in the same series.

Let's revisit stock XYZ. Assuming it is still trading at $60, you could purchase a September 62.50 call for $2.25, and a September 57.50 put for $1.50. Your initial net debit then, is $3.75 for the pair, or $375 total (x 100 shares).

The long strangle then works the same way as a straddle; you profit if the stock moves beyond one of two breakeven points by options expiration: the call strike plus the net debit, or $66.25 in this case; or the put strike less the net debit, or $53.75 in this case. Risk is limited to the initial premium paid for the pair of options.

Advantages and Disadvantages of Straddles and Strangles

Both options strategies favor high volatility. The more a stock swings in either direction, the more you can profit, and the more valuable your in-the-money option becomes (the other option will be out of the money, by default). However, there are advantages and disadvantages to both options strategies.

As demonstrated above, a long straddle is typically more expensive to enter, thus resulting in more dollars at risk. However, the breakeven rails of a straddle are narrower than the strangle, meaning the stock's required move is smaller. For instance, with XYZ at $60, it would take just an 8.3% rally for the shares to top the $65 breakeven of our theoretical straddle. On the other hand, the aforementioned strangle buyer would need XYZ to surge 10.4% in order to top the upper breakeven of $66.25.

In conclusion, long straddles and strangles can be great options strategies to utilize during earnings season. However, options prices tend to rise ahead of known volatility catalysts like earnings, so it's wise to do your research and not overpay. The price you pay for your straddle and strangle options will not only impact your maximum risk, but also your breakeven levels.

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