By Yaser Anwar, CSC of Equity Investment Idea
Today I want to talk about a strategy that can help you play earnings and short term moves in stocks (maybe even long- though I never tried that). The strategy utilizes options and is called long straddle (thanks to my pal Zoltan Kraus for informing about it a couple of months back).
The basic premise of long straddle is- you buy calls and puts of the same price and expiration date, looking for either the calls or puts to appreciate in price depending on whether the stock surprises to the upside or downside.
One risk Zoltan informed me of is if the stock just reports as expected- in this case the calls and puts may not do anything. A risk I’m willing to take.
Before I talk about BBY and GS I’d like to say just utilize this strategy for the "famous" stocks, such as AAPL, CSCO, ORCL or any stock where you believe the upside or downside could be significant. Find out the % of surprise during previous earnings, the options volatility of that stock and how it did during its last earnings date.
So let’s try this with Best Buy (BBY)- it reports on Tuesday and I’m going to give you guys an update on how the long straddle worked for BBY- disclosure- I’m going to put my money where my mouth is.
I’m looking to buy 4 contracts at 2.15/contract of Jan 52.5 (BBYLX.X) calls & 4 contracts at 1.45/contract of Jan 52.5 (BBYXX.X) puts.
Total cost (4 x 2.15 x 100) calls + (4 x 1.45 x 100) puts=) 860 + 580= $1440 + whatever your broker charges for each options contract and trade.
We could have used Dec. 15 expiration for calls and puts but according to Zoltan the time value risk can "kill you". Hence its safer to play at least one month in advance and also find calls/puts that trade close to the same price (like 1.5-2 dollar difference in calls and puts, because calls/puts have to go up a lot to cover one another, so look for options that trade at parity)
He also mentioned that if BBY reports well you can keep the calls into Jan, but remember this will give you additional risk.
That’s about it- let’s see how it goes.