With a nice little win on the BRCM earnings straddle play yesterday and today, we'll try again on AVP. The Options Tab snap (click to enlarge) demonstrates a couple of things:

1) The front month ATM straddle is worth ~$2.20.

2) The front month vol (38) is 5 points above the second month (33) due to earnings vol.

AVP has followed a consistent pattern for six out of the last seven earnings starting with the 10-30-2008 cycle and ending with the last earnings cycle on 4-30-2010. Specifically, a straddle sale at the close on the day of earnings and a purchase back the day after was a winner six times and breakeven once. The Earnings & Dividends Tab for those cycles is included with the relevant values highlighted (click to enlarge).

**What we're lookin' at:**

(1) The top ROW is AVP stock price 5 trading days before earnings through 5 trading days after.

(2) The second ROW are the front 2 month ATM straddles for the same period - focus on purple - the front month.

(3) The third ROW is the implied vol for those straddles - focus on the red - the front month. NOTE: The red line always collapses after earnings - this is called the vol crush after earnings.

The trade statistics for the straddle sale and purchase a day later are included (click to enlarge).

We can see the average win is 23% in one day. One BIG note of caution, though it isn't shown here, on the 7-30-2008 cycle (right before all hell broke loose), the straddle went from $3.60 the day before to $9.60 the day after on a huge earnings move. That's a 162% loss in one day.

If you want to try this strategy, I think an Aug 33 call purchase for $0.10 and an Aug 25 put purchase for $0.10 may be in order to protect against "catastrophic loss." I do like the fact that HV90™ is 32 with the straddle sale closer to 37 vol.

This is trade analysis, not a recommendation.

Legal Stuff:

http://www.livevolpro.com/help/disclaimer_legal.html

Covering the next day in the morning or EOD may make a big difference, the fair value straddle day after is EOD price?

ReplyDeleteYes, def correct.. In this case the stock price could not have been better; i.e. it pinned to $38, so I shut it down.

ReplyDeleteHello,

ReplyDeleteBased on your last paragraph by purchasing the extra insurance it would go down to a credit of $2.00 correct?

Correct. There are aother ways to protect. For example you could do a call spread and a put spread rather than just a naked purchase.

ReplyDeleteto sell or buy those

ReplyDeletei thought we are trying to take in as much profit as we can from the elevated VOL

Buying a put spread rather than buying a put naked allows for a trade on some skew while protecting the downside... But, it leaves an uncoved downside.

ReplyDeleteOn livevol, AVP did not come up on the earnings scan. Is there a way to bring up all earnings candidates? Or how did you find this using Livevol?

ReplyDeleteI find upcoming earnings plays on the Calendar Tab; select "All" radio button.

ReplyDeleteThen I go through the E&D tab to see if I like selling or buying or skipping altogether. Great question, thanks!

just interested - we are looking here for considerable small gains against infinite losses. Isn't it always a negative sum game in a long run?

ReplyDeleteThat depends on what probability you put on the outcomes. Example: Two outcomes; Win = $1, Loss = -$20.

ReplyDeleteProb (Win) = 99%

Prob (Loss) = 1%

Expected Return = $0.79

So even with a 1:20 payout, this is a winner in expected value.

I agree, so am I right here we have:

ReplyDeleteif history means something at all)is

win = 23% of price = 3.58 = 0.85 in your table

loss = 169% of price 3.6 = 6

prob. win = 8/9 = 89%

prob loss = 11 %

Expected return 0.89*0.85-0.11*6=0.76-0.66=$0.1

Is this expected return (if my calculations right) enough for you to consider trade?

That payout is too discretized. There is certainly not 11% chance of 169% loss; but there is also not a 0% chance of a smaller loss.

ReplyDeleteThis is a good exercise; determine what expected return you would require to trade and see if your expectations give you that expected return. If so, we call that edge; if not, we call it negative edge. If negative edge is large enough, you may have found a trade in reverse.

sorry, if we didn't count tomorrows' earnings prob. win = 7/8, than we end up with $0.02 for expected return - I just don't know what should be used correctly

ReplyDeleteYou said "There is certainly not 11% chance of 169% loss", but based on the data presented: 7 wins/1 loss can we do better judgment on probability and amount of loss? Please explain.

ReplyDeleteSo we have 8 data points which are pulled randomly for a probability measure. We will never see the full measure, we can only guess on our random samples. There could be a 1/1000 chance of 169% loss, but we got it in one of our 8 selections (that would be bad luck). We have to make a guess about the probability measure and extrapolate. My point was that the 169% loss was a "bad luck" outcome. Not bad luck in that it was a loser, bad luck in that it is not representative of the actual measure.

ReplyDeleteIf there is an expected value you require to make a trade - then you can construct a probability measure that gives you that outcome and then ask yourself if the measure you've created seems likely based on the random data points we get.

Alexey, you are assigning the probability of a loss at 1/8, which I dont see anything wrong with that, but its that you are assigning a loss of 169% to that 1/8 chance, it could be much lower or much higher...the point is, depending on what you think, you can come up with YOUR OWN expected return.

ReplyDeleteYou averaged out the wins to 23% yet you took the last loss of 169% as your expected loss, why not average the last 8 losses? Dont sell straddles for any significant size until you understand, perhaps just stick to purchases?

So yes, your calculation is correct, if you choose to assign the probability of 1/8th chance of 169% loss... Nobody can well you what the correct probability is. And why must there be a "correct way" to measure the risk? If there is such a thing, dont ya think we'd all be rolling in the dough:)

Thanks.

Well said BB.

ReplyDeleteBB,

ReplyDeleteI certainly understand that loss of 169% is no way any accurate measure of risk and I agree with your points. I was just calculated based on available data. Of course the "true" result will occur only if we measure infinite times the occurred losses and wins but it's not the option in real life. So my calculation was based solely on what was provided by Ophir :) By the way, is this table of % wins can be generated by Livevol or Ophir put everything with hands ih Excel?

I put the data into Excel, but we have a Livevol Excel product which does that as well.

ReplyDelete