Comment by k1

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k1
November 25th, 2007 at 11:40 pm
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.