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k1 Project – Earnings – Dragon’s Story

When Napoleon was asked which generals to take to war Napoleon answered "Give me the Lucky ones." – optiondragon

For the past 4 years I have been perfecting the Earnings 3 ways method. One of my specialties is event catalyst volatility plays. – optiondragon

One of my best friends Dad didn’t believe that I made $200,000 strangling GOOG earnings back in 2005 2nd Q earnings. I run into these people everday. I just shrug my shoulders and move on when they don’t take my ($1000)bet that i did. What are u gonna do? – optiondragon

Earnings are a period of great uncertainty, great volatility, and great possibility. There are a ton of intricacies to the strategies of trading earnings, to take advantage of the volatility or hedge against it. Earlier this year, up until Happy got his own site running, optiondragon shared his insights and tremendous success through Phil’s daily comments. Collected below are a few specific comments detailing dragon’s approach, and clarifying a couple of the key details.

Because earnings periods can be so volatile, and therefore either rewarding or punishing, we’ll use this page to build up other aspects of the strategy as well. First things first, we start with OptionSage’s posts about earnings:

Reading List

Dragon’s Strategy Article

The next key point is an article dragon posted about how to trade Gaps after earnings. The strategy in this post plays a key part in dragon’s earnings approach. Until you read it, you won’t have context to understand a bunch of dragon’s commentary. I’m assuming this link will work, but if not (or if the article moves), I found the original article with the following details:

  • Website: thestreet.com
  • Author: Ken Wolff
  • Title: How to Profit from ‘Gaps’ at the Open

This entry was posted on Sunday, November 25th, 2007 at 11:38 pm and is filed under Education. You can leave a response, or trackback from your own site.

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Comments


  1. k1
    November 25th, 2007 at 11:39 pm | PermalinkIgnore this user

    SShhhhhh….on the Gap trading Method—:) -just make it easy and focus on only 4 patterns to recognize!!!
    1)pop and pop
    2)pop and pop failure
    3)dip,pop and pop
    4)dip, pop and pop failure
    If it gaps down you have to reverse the thinking my young jedi. It reverses. For example FFIV was a reverse “dip, pop and pop failure”. It SHOULD have dropped of the last “pop”. Use 3min chart, japanese candlestick. You’ll see slight variations but the style holds true.

    For awhile I was using a gap trading methodology of opening range breaks but this is better with price action movement recognition. This is simple and contains the important ingredient of self fulfilling prophecy. This is the prevailing methodology so you can bank on it.

    I used to strangle and straddle earnings and biotech catalyst events all the time but it became very difficult after more people started to trade that way pushing premiums too high and made the those trades less profitable. Now I like to take advantage of that and trade after earnings and catalyst events like biotech taking advantage of the IV implosion that is more accentuated because of those same traders. You get a better value but your timing has too be more ON. Your price action recognition skills have to be much more refined. I’ve seen and had astronomical gains playing after the news and catalysts, its much easier to read the analyst reports, read all the data and technicals before making the trade and still get monster gains.
    One of the best plays are a big beat on EPS, big beat on revs, upward guidance.

  2. k1
    November 25th, 2007 at 11:40 pm | PermalinkIgnore this user

    The Pre-Earnings Play

    JCI is looking great what more could you ask for now that you are risk negative!
    You want to add more a little more puts here if it shows weakness but keep the strangle small on the put side. I still am going into earnings overweight long at $3 to $1. If you buy more puts you should buy the July 120 puts.
    I think i have a possible 5 bagger even before earnings just scalping the IV before the event. I could have 20-25 bagger after earnings if they are great from my .50 basis!

    Establishing Direction and Bias

    You have to analyze the numbers and get earnings sentiment to impact probabilities in order to make the highest prob choices available.

    Question: Dragon, when you post earnings strangles, you provide your recommended long/short weighting. What tool/process do you use to figure out the right weighting?

    Answer: Multitude of factors but the main ones are of course techincals, fundamentals, and more importantly sentiment to earnings and expectations. The stronger your bias the more levered direction you put on but if you think it is just going to be volatile do a 1:1.
    It also has to do with my future price projections based on the stock criteria of short interest and float and past gap techincals. I usually like to have some inkling of a bias so the gains will be larger with an educated high probability bet.

    Riding profits into the catalyst event:

    dragon: Juliet, this is the beauty. you can take half off and then get a free ride into earnings for a bigger pop but you need to strangle 1/3 of half the position with the Aug100 puts to insure against losses. Long volatility with a long bias.

  3. k1
    November 25th, 2007 at 11:40 pm | PermalinkIgnore this user

    Hybrid Strangles for Catalyst Events

    Defined: Hybrid is the techinque of starting with one position (in this case pre-earnings run, buy calls outright) then as the event nears, you roll or recalibrate into another play (straddle , strangle), either using your profits for a put position or creating a spread. The thought is your capital changes its goal and risk parameters while using the money gained on the original trade and feeding off the orginal position. It takes alot of practice and also trading experience but you basically try to box your play as best as possible on extreme (+2 or -2)short term standard deviation movements.

    Strangles are better for dramatic swings because the % gain will be bigger with a relatively smaller risk position. Straddles are better for range boundedness because you can sell the dramatic move on the profitable contract then get a good rebound for the other contract but the problem is the IV premium you must pay to break even is very high going into the event and demand is pushing up those premiums too.

    The IV crush following the earnings should not be as bad as if this were options expiration week because of time value cushion and re-accelerated IV after the initial morning IV crush. After opex week I usually like to strangle a little bit wider because of favorable re-accelerated IV after earnings esp after volatility re enters the stock after stabilization. But every case is different and this shouldn’t be the gospel but that is the mechanisms behind options prices after earnings and remaining timeline. The re-accelaration happens due to expected future volatility given the time left to opex. hope you understand that.

    Hybrid Strangle Example: The WYNN Play

    Initial statement: Happy was first on WYNN and we rode that to the bank. I pulled a hybrid strangle with almost zero risk after doubling the early buy and adding some puts for protection.

    Question: optiondragon – could you list the strangle you did on WYNN, especially the “hybrid” and “zero risk” parts.

    Answer: I bought 50 contracts of the AUG 110 at 1.70-1.80, outright for a IV capture long play with earnings at the end of the day. It almost doubled at 3.20 and I sold half then turned the almost pure profit capital into a strangle with buying now worthless Aug 100 puts at a 3 to 1 ratio dollar overweight long thus a hybrid play turning the original outright long IV play into a take almost all your initial original risk capital out after the near double buy some put protection and let it ride. On the zero risk you forgot that word before zero risk which is “almost zero risk” from profit on the original play, which didn’t exist before the hybrid play – to me a free ride is zero risk when playing with the house’s money.

    Question: If the initial Call you buy on the hybrid strangle goes against you, you stop out always? Do you always buy Calls before Puts in the hybrid?

    Answer: Yes usually stop out and reassess, which one to buy first depends on the technicals and bias. You go opposite of what the stock is doing so if it drops hard and is technically oversold you buy calls first then when it flies and starts to look toppy you start cost averaging in with the puts.

  4. k1
    November 25th, 2007 at 11:40 pm | PermalinkIgnore this user

    Weighting the Strangle

    Optrader: OptionDragon, trying to analyze your strangle plays. You recommended earlier, as a new play, to buy the 50 calls and the 45 puts, with a 2.5 dollar weight. That would be 30 calls for each 10 puts, right? In this situation, assuming that we have a 30% volatility crush tomorrow, which seems reasonable, then your break even points would be $36 and $52, anything in between will lose money. Am I missing something or do you feel comfortable with these odds?

    Dragon: Ah, yes, you assume incorrectly depending upon the time to expiration. Since we are far away from expiration an IV crush is lessened if price stability occurs in the opening range. Take a look at BCSI chart for the options to get a good look. The MM or options IV then says wow nice jump so you mean you are going higher even after earnings therefore instead of a 0 to $1 for time value and IV they stabilize it to $2-$3 time and IV from maybe a pre-earnings level of $3-$5 sometimes higher depending on sentiment too, it collapses but at slower stable rate then re-accelerates at a more stable pace than during optionexp.
    Also dollar weighted means $250 call to $100 put.

    Optrader: So do you believe that there will be no IV crush at all? Even if it is the case, break even points in a new position (I know you already bought one leg, but I am working on the new position) should be around $37 and $51, do we agree? Just want to be sure that this is what you would be shooting for. Also, in your strategy, what is your contingency plan if the first leg goes against you pre-earnings? Do you still enter the strangle for earnings?

    Dragon: Usually I have a bias going into it and trade around that thesis. So it is much more complicated depending on factors. I am not a lit major or journalist just a bad ass trader loving to share ideas and make money so I have a harder time articulating exactly how to play this or play that, one day a blue print works another it doesn’t, gut feel has a lot to do with it as well as past technicals.

  5. k1
    November 25th, 2007 at 11:41 pm | PermalinkIgnore this user

    Managing Implied Volatility – Crushes and Rushes

    Optrader: You are not worried of an IV crush on earnings day that will eat your profits on both sides? Wondering if it is a good time to establish a straddle/strangle , especially as IV is high because of Cramer’s pump. Would love to hear what you think.

    Optrader: I should add that I am not arguing about the tactic. Straddles/Strangles are one of my favorite kind of plays: no direction and any kind of big news is good for you: you only get overnight good surprises. But I like to start the positions in a low IV’s environment.

    Dragon: You are right. The risk/reward ratio has changed and this is why you usually cash out completely and then reestablish a strangle with the correct strike prices going into the event. IV crush is always a possibility but with historically volatility off earnings news in JCI, it is of a smaller probability than a volatile move.
    I think it gaps and goes higher after some consolidation thus the AUG esp when demand moves that IV in those calls again.

    Dragon: By reestablishing a new strangle you have better control of the risk capital movements with delta.

    Optrader: Well, you should even take a look at the Jan’s, where IV ATM is at 27% VS 70% for the July’s. It’s more expensive of course, but at least you won’t get crashed on IV drop. You could also buy the Jan’s strangle and sell the Jul’s against it to make it cheaper. Of course that would be a pure IV play, but you can always ratio it.

  6. windywheel
    November 26th, 2007 at 9:25 am | PermalinkIgnore this user

    this looks really interesting, can’t wait to read it.
    thanks k1, you’re the best!

  7. Jordan
    November 26th, 2007 at 12:37 pm | PermalinkIgnore this user

    k1, thank you again for a very insightful article!

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