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Consistent income trading options: ATM straddle prior to earnings

Long Straddle prior to Earnings - AAPL and GMCR
Long Straddle prior to Earnings - AAPL and GMCR

In our quest to understand trading options for income, the topic of this article is the Long Straddle, a strategy that is often employed to take advantage of expanding IV (implied volatility) prior to earnings.

This test was conducted recently by Tasty Trade to determine if this strategy was profitable. Unlike the short Strangle, which takes advantage of IV contraction after earnings is reported, the ATM (at the money) Straddle benefits from expanding IV; the expansion of IV generally falls within the range of 15% to 20%.

Two equities, AAPL (Apple) and GMCR (Green Mint Coffee Roasters) were chosen. The test was conducted over twelve earnings cycles, and the long ATM Straddle was placed approximately 20 days prior to earnings. The position was closed just prior to earnings release, since IV would dramatically drop after the earnings report.

The results: both AAPL and GMCR were not profitable, having lost -$2,475 and -$1,239 respectively. The percent winners were just 33% each, with the largest loss -$1,713 and -$517, and the largest win $2,501 and $302 respectively.

What accounts for the poor results? With less than 10 days till expiration, the rapid drop in theta (time decay) would often offset much of the gains from the expansion of IV. In addition, the IV expansion was offset by a rising market which in the VIX was declining.

In conclusion, buying ATM Straddles 20 days prior to earnings and closing the position just before the earnings report is NOT profitable.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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