Dollar General Corporation (NYSE:DG) : The Volatility Option Trade After EarningsDate Published: 2018-05-11
The results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.
This is a slightly advanced option trade that bets on volatility for a period that starts one-day after Dollar General Corporation (NYSE:DG) earnings and lasts for the 6 calendar days to follow, that has been a winner for the last six consecutive post-earnings cycles. We note the use of strict risk controls in this analysis.
According to our data vendor, Wall Street Horizon, the next earnings date for DG is unconfirmed as of yet, but estimated on 5-31-2018.
Dollar General Corporation (NYSE:DG) Earnings
In Dollar General Corporation, irrespective of whether the earnings move was large or small, if tested waiting one-day after earnings and then tested a long an one-week strangle (using options that are closest to two-weeks), the results were quite strong.
Simply owning options after earnings, blindly, is likely not a good trade, but hand-picking the times and the stocks to do it in can be useful. We can test this approach without bias with a custom option back-test. Here is the timing set-up around earnings:
* Open the long out-of-the-money 40 delta strange one-calendar day after earnings (that's long the 40 delta call and the 40 delta put).
* Close the strangle 7 calendar days after earnings.
* Use the options closest to 14 days from expiration (but more than 7 days).
This is a straight down the middle volatility bet -- this trade wins if the stock is volatile the week following earnings and it will stand to lose if the stock is not volatile. This is not a silver bullet -- it's a trade that needs to be carefully examined.
But, this is a stock direction neutral strategy, which is to say, it wins if the stock moves up or down -- it just has to move.
Since blindly owning volatility can be a quick way to lose in the option market, we will apply a tight risk control to this analysis as well. We will add a 40% stop loss and a 40% limit gain.
In English, at the close of every trading day, if the strangle is up 40% from the price at the start of the trade, it gets sold for a profit. If it is down 40%, it gets sold for a loss. This also has the benefit of taking profits if there is volatility early in the week rather than waiting to close 7-days later.
Another risk reducing move we made was to use 14-day options and only hold them for 7-days so the trade doesn't suffer from total premium decay.
If we bought the out of the money (40 delta) strangle in Dollar General Corporation (NYSE:DG) over the last six-earnings cycles but only held it after earnings we get these results:
The mechanics of the TradeMachine™ are that it uses end of day prices for every back-test entry and exit (every trigger).
Looking at Averages
The overall return was 249%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 40.7% over 6-days.
We don't always have to look at bullish back-tests in a bull market -- sometimes a straight down the middle volatility pattern pops up. This is it -- this is how people profit from the option market -- finding trading opportunities that avoid earnings risk and work equally well during a bull or bear market.
To see how to do this for any stock we welcome you to watch this quick demonstration video:
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Thanks for reading.
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.