PayPal Holdings Inc (NASDAQ:PYPL) : The Volatility Option Trade After Earnings
Date Published: 2018-07-24
DisclaimerThe 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.
LEDEThe week following PayPal Holdings Inc (NASDAQ:PYPL) has had one fairly consistent pattern -- volatility. If we take a myopic view after looking at the last three-years and focus on the last six-months, that pattern is yet more decisive.
PayPal has earnings due out on 7-25-2018 after the market close according to Wall Street Horizon. One-day after that would be 7-26-2018, and that's where this back-test focuses.
PayPal Holdings Inc (NASDAQ:PYPL) EarningsIn PayPal Holdings Inc, irrespective of whether the earnings move was large or small, if we tested waiting one-day after earnings and then holding a long out of the money (40 delta) strangle for one-week (using two-week options), the results were quite strong. This trade opens one-day after earnings were announced to try to find a stock that moves a lot after the earnings announcement.
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:
Rules* Open the long out-of-the-money (40 delta) strangle one-calendar day after earnings.
* 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.
RISK CONTROLSince 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.
RESULTSIf we bought the out-of-the-money strangle in PayPal Holdings Inc (NASDAQ:PYPL) over the last three-years but only held it after earnings we get these results:
The mechanics of the TradeMachine® Stock Option Backtester are that it uses end of day prices for every back-test entry and exit (every trigger).
We see a 174% return, testing this over the last 11 earnings dates in PayPal Holdings Inc. That's a total of just 66 days (6 days for each earnings date, over 11 earnings dates). That's a annualized rate of 931%.
Looking at AveragesThe overall return was 174%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 17.2% over 6-days.
➡ The average return per winning trade was 43.7% over 6-days.
➡ The average return per losing trade was -29.1% over 6-days.
Most Recent HistoryWe can do this same test but focus in on the last two earnings releases (6-months of history). Here are those results:
The overall return was 97%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 51.9% over 6-days.
WHAT HAPPENEDThis is how people profit from the option market. Take a reasonable idea or hypothesis, use a rationale system to help overcome cognitive biases, and test it. Tap the link below to learn more:
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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.