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Straddles vs Butterfly Option Trades on Earnings

Today we have a more advanced question about options trading, some earnings, and IV crush.

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If you have a specific question that you want me to answer about stocks, options, investing, feel free to submit one by voice here!

Today’s question is a little bit more intermediate to advanced, and I’ll see if I can break it down and explain it for you in detail.

“Hey Sasha, I hope you’re doing well today. My name is Artem. I’m pretty new to option trading (not even four months in), and I have a question regarding option strategies for post-earnings IV crush.

I know the Iron Condor is a great strategy, but that limits me into a price range. And a lot of times, post-earnings prices may jump significantly up or down.

I’m also wondering if there is sort of it like a long straddle but inverse where you could sell the premium. I know that I was playing around on thinkorswim, and selling a double diagonal or a double calendar does result in the negative Vega.

But the risk I have is unlimited, and I’m not able to go with that trade. I was wondering maybe there’s something I’m missing. Because I want to know if there’s a strategy where I could make money if the stock price moves away from the strike and price by a great deal. And if the IV of the option goes down as well together.

Let me know. Thanks so much, and I hope you keep making videos for a long time. Take care!”

Thanks, Artem!

First, we’re going to try to explain the question just because I think some people may not understand where we’re going with that.

And then the second thing is I’ll show you some ideas and things to think about.

Remember, when you’re trading earnings, it’s a guessing game. Even if earnings are great, stocks may sell-off. Even if earnings are bad, stocks may pop higher due to future expectations, whatever the case is.

Understand it’s a guessing game with earnings.

After Earnings there is an IV Crush

There’s an IV crush, meaning it compresses. There’s volatility, and then earnings come out, it gets crushed.

When we look at these things, he was looking at a long straddle.

Here’s our long straddle.

You get one of these before earnings. And then all of a sudden, either stock goes down, or stock goes up.

And you make money one way or the other. The downside is you pay a lot on your theta because you’re losing big time.

That’s because you’re buying each options right at the money, which are the juiciest. But you also have positive Vega. He’s thinking well what about something inverse?

Well, how about we do something like this?

This is what he was looking at. Now you have a positive theta. You can wait for a couple of days until the earnings come out.

And then once earnings explode, well ideally you’d want to be making money.

But in this case, you have that unlimited risk he was saying.

What he was then looking at is Iron Condor.

Here I have an Iron Condor setup.

I’m just using Tesla as an example.

In this case, this is what he wants. 

He wants that theta. In addition, you have that negative Vega.

But the difference and the problem is you’re confined.

That’s the problem. Whereas the other ones with the straddles and strangles, you’re a lot less confined than you are here with this Iron Condor. You’re confined. And it becomes a problem. In the market, there are always trade-offs.

If you want to shoot video in low light and you don’t have light, you’re going to get a grainy picture. Or you have to get a way better camera.

Being aware of Trade-offs in Trading 

There are always trade-offs. And the same thing here. There are some advanced strategies to tweak things.

Remember, with earnings; you don’t know if it’s up or down. What you would do is you would take these two strikes right here, and you bring them in.

And then you would have a butterfly.

And this would go create a trade that’s a little bit more like this.

You could do this butterfly with this Iron butterfly, which means you’re splitting the calls and puts. It doesn’t matter.

Or I could do a butterfly where it’s all calls or all puts. With a butterfly taking a guess to the upside, taking a guess to the downside with puts – all works out.

You’re spending about $267 to take a chance on these. And when you do that chance is might lose a lot of your premium. You might make a lot of money.

But you don’t know. Even though here it says a positive vega, you can’t let that throw you off. Because remember when it comes to that butterfly, once you start moving into this direction, you’re going to be negative Vega.

That’s what you’re trying to capitalize on. That’s the name of the game if that’s what you’re looking for.

For some people, you could put it right at the money. I don’t have an example like that, but let me make one real quick. You could say I’ll put one right at the money. And that’ll be around 230 right now. And let’s go to a 250 and a 210 to get numbers even.

You could put one in the money. But of course, just like with the iron condor, you’re in this range. 

It creates a little bit of a problem. In some cases, what people do is they create a double butterfly. And now even if the stock price doesn’t move much, we don’t lose a lot. It cost you a little more to put this on because if you do a single one, it cost you about 350.

If you do a single on the other one 276 and to do both, you’re about $600. However, your loss is probably about maybe half of the other one. And sometimes it’s not even worth it because you’re trading more contracts. That means that commissions could be a problem.

But if it goes down or up quite a bit, you’re still capitalizing on it. That’s the normal and healthy way I would say to trade earnings as far as a single strategy goes. I wouldn’t get into anything too much more crazy than that.

The main reason is what’s happening now is you want to sell premium. But you also want unlimited movements, and it’s almost trying to get too much for what you’re trying to do.

Instead, I would tweak a strategy and make it much more simple. Even a single butterfly, pick a direction one way or the other. You can also do it with a vertical if you want. Look at it like that rather than trying to cram in.

Here is our straddle trying to make as much as possible on the move versus something like this trying to still make the theta.

You have to pick your battles. If you want theta or you want movement. You always have to pay for it; nothing is free. 

In martial arts, there was a rule that we always went by: Everybody works. Nothing is free, and everybody starts at the bottom.

The thing is we can’t have everything in the marketplace. There are always trade-offs. If you’re trying to get something like an unlimited movement, but without paying too much to get it in both directions is tough.

I will show you one strategy where you can do it in a single direction, and you could be more creative. You could be able to maybe do it in both directions. But again, be aware there are some serious risks associated with it.

Why is that?

Well, because what we’re going to do is a back ratio spread. I’m not a huge fan of them, but I’ll show you how it works. And the profit picture for it.

I want unlimited profit right. I want an unlimited movement to the upside. Let’s say I’m betting that this stock is going to head higher. Well, if this works out, what I’m doing is I’m selling one.

And you’re selling one in the money, or it may be in the money after earnings. I could do one a little bit even tighter 240, and I could do a 230. You could see also if it sells off in a big way or doesn’t move, I might be able to make some money on it. That’s because I’m selling a 230 and buying 250.

What does that mean?

 I’m selling a 230 I’m selling this one and buying a little further out it’d be to 250.

I’m doing one of these and a 230. I’m selling one of those and buying two of those. When I sell these, it offsets the cost of that. That’s because it’s at the money. 

The downside with this is if this pulls back, and it stays under that 235 while I sold one that means I could be liable for the stock price at that price.

If it explodes, it works out in your favor. And you also have a sea of death problems here, which is about $1100.

This is another way to play a directional move. When you look at this move, it’s still not negative Vega. It’s still positive Vega, but you have price movement.

How Could You Combine Two of These?

You can. Let’s show you an example here on the put side.

Let’s say I’m doing the puts, but there are some serious risks associated with that. We’ll go with 205, and I have 210 here. Make it a live price.

You can see paying a little bit. Remember, the more you move this around, the profit picture starts to change.

If I don’t want to risk a lot or pay pretty much nothing if the stock doesn’t move, that means for me to make a profit, it has to tank. Whereas if I’m willing to risk a little bit and it doesn’t have to move as much.

If I do two of these together, you could get something like this.

Call it like Batman.

You could get something like this without paying too much. And you can see if it doesn’t move, then you’re not paying too much, but you have this – they call it the sea of debt.

These two little problems just like bat wings. You’re going to be in the money on one of these. And that, of course, is a huge issue where a lot of traders don’t like to be in the money.

Be aware that this one has some serious risks. But anyway, that could be something you look at or investigate. I usually would recommend keeping things simple.

Keeping Things Simple in Trading

A simple butterfly one way or the other for earnings, you’re risking maybe $300 to double your money potentially. And that’s an excellent movement.

Let’s say you go a few days into it, and then you had the implied volatility that went with it, you’re risking about $300 to maybe make about $300. And it’s to double up your money. That’s some pretty good serious return on investment.

I hope this was helpful to get you thinking about some things. I know we’ve covered some more intermediate to advanced things. I usually don’t like to get too crazy or too complicated on the trades.

That’s because I find once you start putting a lot of them (10 earnings trades), it becomes harder to manage.

You need to think about how do you adjust, the fix, what’s your plan. It just becomes more convoluted and blurry. My advice is to keep it simple.

It’s up to you. My goal is to teach you a little bit, and then you can make it your own.

A camera in one person’s hand will take a different picture than a camera in another person’s hand. Everybody sees things a little bit different.

Final Word

There are some things for you to take away and walk away with, and you can now make it your own. 

I hope that was helpful.

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