As a trader, the months I always found the most interesting to trade were the earnings months. During the earnings season, customers would play a plethora of approaches. However, I think the most common approach is the earnings straddle.
Since the company went public, no earnings straddle has been more fun to play, or more interesting to watch than Google (GOOG). This is because, in a typical year, three out of its four earnings announcements happen on the evening before expiration.
While most other companies earnings have at least SOME time until expiration following their announcement, making the true earnings straddle at least somewhat opaque, Google earnings expectations are almost perfectly clear. There is one day to react following the earnings announcement, then the options expire.
It is because of the timing of its earnings that GOOG is such an interesting case study of earnings plays.
I have compiled a list of the price GOOG closed at prior to its earnings announcement, the straddle price and percent of stock value, and the amount the stock moved after the earnings announcement.
For the January cycle, I estimated the value of the earnings straddle by subtracting what the straddle would be in a non-earnings month, and then made an adjustment for the overnight decay of that straddle. I used the last four cycles because, despite the differences in price and implied volatilities, the general market conditions have been very similar: rallying with implied volatilities falling.
Source: LiveVol Pro and thinkorswim
When I started plugging in the numbers, I was almost certain that the Google straddle would be a screaming buy at a little over 4%. It turns out that the straddle has rarely been a winner over the last year. Even stranger, the only win was the one month where the straddle had extra time because it was at the beginning of the expiration cycle.
The lesson here, despite the appeal of trading the big name, is that it does not appear to be a great play to buy the GOOG straddle heading into earnings. Based on this understanding, it would actually make sense to sell premium into GOOG earnings, but that is a topic for another writer.
As I stared at the numbers wondering what to think about GOOG earnings, I noticed something very unique. I ran a very similar analysis on GOOG if the trader bought an at-the-money (ATM) straddle a week before earnings instead of the day before earnings. I also used the closing price of the straddle as opposed to the movement of the underlying. This is because the stock may have already moved away from the straddle even before earnings were released. The stock could also move back toward the straddle from the week earlier. This makes looking at the straddles closing price a more effective way of measuring value.
Source: LiveVol Pro
Traders may notice that buying the GOOG straddle the week before earnings are announced is actually consistently a winner. Looking more closely at the numbers, if traders sold the straddle the day BEFORE earnings, the trader did even better:
What is the point of all these numbers?
When I was a child on Christmas Eve, I could hardly sleep I was so excited for Christmas (so I still do that, so what???). The next day, no matter how great Christmas was, there always seemed to be a bit of a letdown. It appears that GOOG earnings have a similar problem.
Traders might not want to buy options on “Christmas Eve.” It appears better to buy options earlier in the cycle. In our Christmas example, it would be when “A Charlie Brown Christmas” airs, and then either hold through “A Christmas Story,” or even sell on “Christmas Eve.”
Essentially, if the trader buys the options before the Street moves in to buy the straddle, then the trader has a strong chance at success.
Related Articles:
- 5 Rules of Engagement for Trading Earnings
- 6 Expiration Day Traps to Avoid
- Straddles: When You’re Not Sure
Top 5 Stocks for April
With rising earnings, a strong balance sheet and a powerful new product line (all despite the recession!) these five stocks are set to outperform the market in the short-term. Get their names here.
