Twice a year, there are two periods where many listed companies on our market report their earnings and give forward guidance. For the next few weeks, many stocks will have volatile movements off the back of their reporting – which provides great trading opportunities. Instead of buying and selling shares though, many of our clients decide to utilise a unique Options strategy – the long strangle, or straddle.
Here is a breakdown.
The Strategy: Long Strangle
- Profits from both a rise, or fall in share price.
- No strong directional view needed.
- Must have a certain amount of either bullish or bearish movement.
- Movement must occur quickly (within a few days).
- Can be skewed to be more bullish or bearish if desired.
When to Use
- Other volatility events where large share price movement is expected.
- A hedge is needed.
If Trading the Report:
- Check historically how much the stock moves on its report.
- At least 5% movement needed (rule of thumb).
- Consider entering a couple days prior (instead of the day before) as implied volatility will likely rise leading into the report.
Example: ASX Ltd
The ASX is a company listed on its own exchange. You can buy stock in the actual stock market. It is currently trading at $85.73.
- Reports in two days (10th of February).
- Risk = Premium: $6,196.50
- Profit target is a 4 – 5% share price movement.
Below is the payoff matrix of the trade above. The Y axis on the left is the share price range and the X axis up the top is the time range. The middle share price of the Y axis is the current share price at $85.73. The numbers above it are 1% share prices increases. The numbers below it are 1% share price decreases. The X axis simply shows today’s date and the following seven days. By looking at this matrix we can project into the future and see what our rough profit and loss would be at different times and different share prices. It only shows profit or loss – for example, if the share price rises to $89.16 (4% higher than the current share price) by the 10th of February, then roughly $1,819 profit is made. You would therefore sell your original position for roughly $8,000 ($6,196.5 + 1,819).
Quick matrix takeaways:
- A 5% rise or fall is a good profit (about 30 – 50%) on the day of report (10th of Feb).
- If the report does nothing, provided we close in the following days we can limit losses (about 10 – 20%).
- The longer we stay in the trade, the less profit is made, and the worse our losses get.
- Breakeven on about a 2% rise or fall.
Although this strategy seems simple enough, the danger is in the detail. Volatility shifts need to be accounted for. There are little adjustments that make an impact that a beginner trader won’t know to do. We suggest you only try this strategy if you already have a strong Options background or have a mentor (like we provide).
If you are interested in learning how to trade these strategies and want a mentor to hold your hand, get in touch by emailing Advisors@traderscircle.com.au or by calling 03 8080 5788.
Want to learn how to trade?
The team at TradersCircle/Emerald Financial have release a free online stock market education course, click here to enrol and get started.