There is a wonderful secret to trading options right before earnings announcements in Ascena Retail Group Inc (NASDAQ:ASNA) , and really many stocks, that benefits from the rising implied volatility but avoids the risk into the actual earnings release and also avoids any kind of stock direction risk.
Everyone knows that the day of an earnings announcement is a risky event for a stock.
The question every option trader, whether professional or amateur, has long asked is if there is a way to profit from the known implied volatility rise. It turns out, that over the long-run, for stocks with certain tendencies like Ascena Retail Group Inc (NASDAQ:ASNA) the answer is actually, yes.
THE WONDERFUL SECRET
What a trader wants to do is to see the results of buying an at the money straddle a few days before earnings, and then sell that straddle just before earnings. The goal, is two-fold: (i) to benefit from that known implied volatility rise, and (ii) to own the straddle for a very short period of time when the stock might move ‘a lot,’ but taking no earnings bets.
If either of those two phenomena occur, there’s a very good chance this wins, if neither occur, the amount risked is normally quite small.
This trade is not a panacea, which is to say, we have to test it, stock by stock, to see when and why it worked. We start with Ascena Retail Group Inc.
Here is the setup:
We are testing opening the position 6 days before earnings and then closing the position 1 day before earnings. This is not making any earnings bet. This is not making any stock direction bet.
Once we apply that simple rule to our back-test, we run it on an at-the-money straddle:
If we did this long at-the-money (also called ’50-delta’) straddle in Ascena Retail Group Inc (NASDAQ:ASNA) over the last three-years but only held it before earnings we get these results:
|Long At-the-Money Straddle|
|* Monthly Options|
|* Back-test length: three-years|
|* Open 6-days Before Earnings|
|* Close 1-day Before Earnings|
|* Holding Period: 5-Days per Earnings|
|Pre-Earnings Straddle Return:||25.9%|
We see a 25.9% return, testing this over the last 11 earnings dates in Ascena Retail Group Inc. That’s a total of just 55 days (5 days for each earnings date, over 11 earnings dates). That’s an annualized rate of 172%.
We can also see that this strategy hasn’t been a winner all the time, rather it has won 8 times and lost 3 times, for a 73% win-rate and again, that 25.9% return in less than two-full months of trading.
Here is a 1-minute and 25-second video that shows you exactly how to do this for any stock and what every professional option trader would rather that you don’t see.
Learn more here: Try the Back-tester Yourself
<br /><b>MORE TO IT THAN MEETS THE EYE</b> <br /> While this strategy is benefiting from the implied volatility rise into earnings, what it’s really doing is <b>far more intelligent</b>.
The option prices for the at-the-money straddle will show very little time decay over this 5-day period, so what this strategy really does is buy “five days” of potential stock movement with what is actually fairly small downside risk.
That means the ideal stocks for this strategy have a couple of common characteristics:
(i) The companies rarely pre-announce earnings — this is an investment that does not look to make an earnings bet, so an earnings pre-announcement is the opposite of what we’re hoping for.
(ii) The underlying stock price of these companies tend to move a lot (or some) as earnings approach and various institutions and traders shuffle the stock price around in anticipation of the earnings result. The more one sided the outside world starts betting on direction — up or down, the better it is to own the straddle.
Take a reasonable idea or hypothesis, test it, and apply lessons learned — this is how people profit from the option market.