Option Intelligence: The Volatility Trade After Earnings in Alphabet IncDate Published: 2018-01-23
The full written dossier is incuded below, but this 2 minute video illustrates the mechanics as well:
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.
The market is ripping. January, thus far, has been off the charts strong for technology and industrials and it is a reminder that while following the trend with momentum has been a huge winner -- that can end, and it can end abruptly.
But that means the market may be a coiled spring -- it may pop higher or dive lower -- and that makes for opportunity.
Today we look at a different approach -- the idea that whether there is good news or bad news from tech earnings, the stocks may be set up for a wild ride right after the event, and we don't care if it's up or down.
Alphabet Inc (NASDAQ:GOOGL) has earnings due out on 2-1-2018 after the market closes and we have already examined the bullish momentum pattern into that event. Now we look at the possibility and pattern of a large move in either direction after the event.
Alphabet Inc (NASDAQ:GOOGL) Earnings
In Alphabet Inc, irrespective of whether the earnings move was large or small, if we waited one-day after earnings and then bought an one-week out of the money iron condor (using weekly options), the results were quite strong. This trade opens one-day after earnings were announced at the end of the day, so in this case 2-2-2018 at the close, 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:
* Open the long an out of the money iron condor one-calendar day after earnings.
* Close the long iron condor 7 calendar days after earnings.
* Use the options closest to 7 days from expiration (but at least 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 iron condor 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.
HOW AN IRON CONDOR WORKS
In this case we are looking at the long 40/10 iron condor. In English, the back-test is looking at this trade:
Buy the 40 delta call and sell the 10 delta call (this is just long a call spread).
Buy the 40 delta put and sell the 10 delta put (this is just long a put spread).
Here's a picture to help illustrate:
If we bought the out-of-the-money iron condor in Alphabet Inc (NASDAQ:GOOGL) over the last three-years 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).
We see a 736% return, testing this over the last 12 earnings dates in Alphabet Inc. That's a total of just 84 days (7 days for each earnings date, over 12 earnings dates).
Looking at Averages
The overall return was 555.1%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 51.8% over 7-days.
➡ The average return per winning trade was 82.7% over 7-days.
➡ The average return per losing trade was -41.2% over 7-days.
Looking at the Last Year
While we just looked at a multi-year back-test, we can also hone in on the most recent year with the same test:
Now we see a 112.9% return over the last year and a 75% win-rate.
➡ The average return for the last year per trade was 29% over 7-days.
➡ The average return for the last year per winning trade was 54.8% over 7-days.
➡ The average return per losing trade was -48.2% over 7-days.
We found this back-test by going to the Trade Machine Pro scanner and looking at the Nasdaq 100 as our ticker group, and then the "7-days post earnings long straddle" scan. We then tinkered a bit, and turned it into an iron condor by adding the short out of the money options.
Here are the results:
We note that Google had the most wins over the last 3-years with this approach, more than any other constituent in the entire Nasdaq 100.
Bull markets tend to create optimism, whether it's deserved or not. To see how to find the best performing historical momentum, technical analysis or non-directional trades for any stock using empirical results rather than guesses, we welcome you to watch this quick demonstration video:
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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.