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A brief summary of how to trade expected, large directional movement

 

One of the key advantages of using exchange traded options is the ability to profit from a diverse range of share price movements. This can be advantageous around company reporting seasons, as you can often expect large movements from share prices, even if you are uncertain which direction that movement will be.

This article will focus trading large amounts of movement in either direction, but more advanced traders may consider trading other views around reporting.

Start by selecting a stock that you think will see large amounts of movement. You can view a calendar of reporting companies on our website, and this is a great place to start a short-list. Next, consider what might cause a stock to see above average levels of movement; this could include large share price movements through-out the year, large amounts of recent news coverage, or traditionally large movements around reporting season.

Once you have the companies and dates that you are targeting, its about considering the strategy and implementation. It is our experience that it is best to place most each-way strategies two-days or more before the actual earnings report; this is because market makers will generally raise the “implied volatility” of options the day before an earnings report (entering during higher implied volatility means that you will need relatively more share price movement to profit on your strategy).

Next you will consider the strategy to use. There are a few different multi-directional strategies that you can use. The simplest of these are straight straddles and strangles; these involve simply buying a straight call and straight put.

A simple straddle involves buying both a straight call and straight put at the same strike price and expiry for a given company. You would usually want to purchase at a strike price that is centred on the current share price, or where both the Call and the Put have a very similar delta.

For example: Buy CBA $70.00 February Call and Buy CBA $70.00 February Put. Under this scenario you would want CBA’s share price to move as far from $70.00 as possible.

A simple strangle also involves buying both a straight Call and Put. However, with the strangle, you will purchase a Call above the current share price, and a Put below the current share price. Some traders do this buy simply purchasing a Call one strike above the current share price, and a Put one strike below the current share price. However, another way of implementing this strategy is to select Call and Put strikes that have similar deltas, with strikes that aren’t too far from the current share price.

For example, consider that CBA is trading at $70.00, you may consider Buying a CBA $70.00 February Call (0.4 Delta) and Buying a CBA $67.00 February Put (-0.4 Delta).

Delta is a measurement of how much the value of the option will change with changes in the underlying share price. By selecting options with similar deltas, you are ensuring that upwards and downwards movement are of similar value to you, and that the trade is not favouring one direction or the other.

Finally, you want to simulate the trade. The TradersCircle options calculator is perfect for this, because you can simulate changes in share price, as well as changes in volatility. You want to ensure that you can profit on the trade after a realistic amount of share price movement, as well as a reduction in implied volatility – which usually occurs after a company reports earnings.

If you are interested in making a trade around reporting season, don’t hesitate to contact your TradersCircle adviser on 03 8080 5788.

We will also present a special webcast Tuesday 5th of February at 7:00 PM AEDT. (You can register for this free webinar by clicking here).