Using The Option Straddle
Using The Option Straddle
Every earnings season I get questions about what option strategy to use. I hear things like, “What’s the best strategy to use to play earnings?” or “How do I use options to make money on earnings?”
With options, there are always several right answers. However, for new traders, I usually recommend buying an option straddle.
As a reminder, buying an option straddle is when you buy both a put and a call at the same strike in the same month for a particular stock, ETF, or index. You can read a summary of how a long straddle works here.
The option straddle is the easiest way to profit from big earnings moves.
Stocks tend to move a lot more than usual after earnings (especially if there’s a surprise). However, it’s hard to know if the surprise is going to be positive or negative.
That’s where the straddle comes in.
With a long straddle, you don’t have to guess the direction… you just need the stock to move. The straddle allows you to make money (with unlimited upside) if the share price moves a lot, either up or down. Plus, you can only lose the amount you spent on the trade.
Here’s the thing…
It’s important to know when to use a straddle. Don’t just go out and buy a straddle on Google (GOOGL) before earnings, because it will be extremely expensive. High priced stocks will always have very pricey straddles.
Moreover, extremely volatile stocks will have expensive straddles as well. The share price will have to move an extreme amount in order to justify the cost of the straddle.
The best bet is to find a company that doesn’t tend to be too volatile, but one you think could report surprise earnings. The stock price should also not be too high. Anything over $100 or so per share is going to be cost prohibitive.
I talk about this strategy in more detail here.
If done correctly, using the long option straddle can be a very good way to make money during earnings season. Keep in mind, long straddles of any type can be more costly than other types of trades.
To reduce costs, you could instead use an option strangle, where you buy out-of-the-money calls and puts. It’s a lower probability trade, but it’s also cheaper. I’ll talk about strangles in another article.
On the other hand, you could also go short an option straddle.
Shorting straddles is an advanced strategy that can often have a high probability of success. It can be used when straddles get too expensive in volatile stocks heading into earnings.
The problem with short straddles is they carry unlimited risk. I don’t recommend this type of trade for anyone who’s risk averse or new to options trading.
For an interesting straddle case study, check out this SPDR S&P 500 ETF (SPY) chart:
In this case, the SPY has been more volatile than usual since 2015 began. This may seem like a good time to use a long option straddle. However, because the SPY has been trading in a range the last several weeks, the movement is already priced into the straddle.
In other words, you’d probably be lucky to break even buying SPY straddles because it’s not a surprise scenario. Short straddles would be the better choice here, although once again, it’s an extremely risky trade.
Yours in Profit,
Gordon Lewis
Options Trading Research
Note: Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com. You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.
Category: Options Trading
