How to Trade Options Before Earnings in Broadcom Limited (NASDAQ:AVGO)
How to Trade Options Before Earnings in Broadcom Limited (NASDAQ:AVGO)
Date Published: 2017-05-15Preface
Trading options in a short window before earnings are released benefits from the rising implied volatility but avoids the risk into the actual earnings release and also avoids any kind of stock direction risk.
This approach has returned a annualized rate of 198%. Now that's worth looking into.
STORY
Everyone knows that the day of an earnings announcement is a risky event for a stock. This can be explicitly seen in the option market, where the implied volatility (the expected stock move) rises into the earnings event.
The question every option trader, whether professional or amateur, has long asked is if there is a way to profit from this known volatility rise. It turns out, that over the long-run, for stocks with certain tendencies like Broadcom Limited (NASDAQ:AVGO) the answer is actually, yes.
Yes, there is a systematic way to trade this repeating phenomenon, without making a bet on earnings or stock direction.
THE SET UP
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. 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:
RETURNS
If we did this long at-the-money (also called '50-delta') straddle in Broadcom Limited (NASDAQ:AVGO) 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 | |||
| Winning Trades: | 5 | ||
| Losing Trades: | 7 | ||
| Pre-Earnings Straddle Return: | 17.1% | ||
| Annualized Return: | 102% | ||
We see a 17.1% return, testing this over the last 12 earnings dates in Broadcom Limited. That's a total of just 60 days (5 days for each earnings date, over 12 earnings dates). That's a annualized rate of 102%.
We can also see that this strategy hasn't been a winner all the time, rather it has won 5 times and lost 7 times, but here's the key -- it wins about half of the time, but the average gain per winning trade is substantially larger than the average loss on a losing trade:
Consistently Successful
This idea has also been a successful approach over the last two-years:
| Long At-the-Money Straddle | |||
| * Monthly Options | |||
| * Back-test length: two-years | |||
| * Open 6-days Before Earnings | |||
| * Close 1-day Before Earnings | |||
| * Holding Period: 5-Days per Earnings | |||
| Winning Trades: | 4 | ||
| Losing Trades: | 4 | ||
| Pre-Earnings Straddle Return: | 22% | ||
| Annualized Return: | 198% | ||
Now we see a 22% return, testing this over the last 8 earnings dates which is a annualized rate of 198%.
Yet again, we see a trade that wins about half the time, but the average win is much larger than the average loss:
If you really want to see how we found this, and how to do it for other stocks like Apple, Google and Amazon, here is a 1-minute and 34-second video that every professional option trader would rather that you don't see.
Learn more here: Try the Back-tester Yourself
WHAT HAPPENED
There are patterns to stock behaviors before and after earnings and those patterns reveal opportunities in the option market, without taking the actual risk of earnings. You can find them, stock by stock. This is how people profit from the option market -- it's preparation, not luck.
To see how to do this for any stock we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work
Thanks for reading.
Risk Disclosure
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.
Back-test Link