New Volatility Straddle on the Horizon - Amazon.com

I was looking at the volatility chart for Amazon yesterday and noticed it had all the characteristics needed to make a great IV rush play. The logic behind this is the same as the Adobe Straddle play I have going on right now.

Amazon is going to release Quarterly Earnings around July 24 (give or take a day or two, this is when they have in the past 2 years). As you will easily see in the graphic below, Options on AMZN experience a significant increase in their Implied Volatility. Currently the IV for Options on AMZN remains near the rolling 12-months' low. I will continue monitoring AMZN but expect to initiate a Straddle (buy Calls and Puts at the same Strike Price and same Expiration Month) somewhere in the middle of June.

Cheers.

ADBE Volatility Straddle Update

Implied Volatility of the underlying decreased almost a full point (.93%). The Long Straddles I've purchased are naturally long Vega so this decrease hurts the position. As I have learned the farther-out options have a higher Vega (in this case the Jan 09 has a Vega of 26.62 while the Jun 08 has a Vega of 7.55), and as such the Jan 09 lost more due to the decrease in IV than any of the others. Delta risk and Theta risk partially offset each other thanks to another up move by the underlying stock.

Thoughts
I do not expect IV to continue decreasing, especially as this weekend will move us 2 days closer to the Earnings Announcement. Theta risk will be the biggest hurdle over the weekend as the positions will lose the Theta number * 2. I'm looking for an increase in IV on Monday

I've attached a chart I through together showing the moving values of IV for each position:

Interesting thing to note: Jun has highest IV and also most Volatile IV (not trying to be confusing). The Jan 09 option has the lowest IV and also is the least volatile. While it is good that the Jan 09 option has the highest Vega, it looks like IV may have more trouble increasing for this option than for the Jun 08 option. We will see how this plays out as we approach Earnings.

Lastly, here is the position update:

Cheers.

Dell Straddle Review

Dell opened up a little bit lower than the high of after-hours trading but then climbed back up pretty quickly to gain 10%. Had I sold the Jun 42.5 Straddle around that time it would've netted around 35% profit. Dell has since drifted lower and is now up approx. 6.5%. Currently the Jun 42.5 Straddle would net a 4% profit if I sold. For now, I am holding on to the position, hoping for an upward rally later in the day that I could sell into benefiting from the Delta.

Lesson Learned: Sell Long Straddles quickly
after event-driven Implied Volatility run-up is over due to news release. IV is
staring to drop now and for the Straddle to be worth more we are going to have
to rely on our Deltas. I'll give an update after I do sell the Straddle.

Update - 2:00pm (Central Time):
Well I decided to close out the Dell 42.5 Straddles, here are the results:

I knew that IV's would drop, but I was holding out hoping that the stock would move even more. Next time I play an earnings announcement like this, I will be sure to sell into the open when IV has not yet dropped.

Given that the nearest-month option experienced the largest profit due to the higher level Delta and lower level of Vega, I now know that a nearer-month option is best for these short-term straddles. No matter how you look at it though, 7.8% profit in 2 days ain't bad.

Cheers.

Update 3 - ADBE Volatility Straddle

Today was a good day for all four of the ADBE 42.5 Straddles. I don't have much time as some friends are coming over tonight for the Season Finale of Lost, but the attached graphic shows what I'm thinking:

Update on DELL straddle--
As expected, the straddle remained unchanged throughout today as the market waited for news after the market closed. Turns out the news was great and Dell has risen 9.72% in after-hours trading. I stumbled across a news article that mentioned that historically, the after-hours move of Dell in response to Earnings Announcements will carry over in to the following trading day with a strong continuation. While I expect the 9.72% move to offset the certain drop in IV tomorrow morning; I'm also hoping for some additional moves up.

Cheers.

Scalp: DELL Earnings Released Tommorow

Dell is releasing Earnings tomorrow after market close. It will be interesting to see their results given the shabby shape of our economy in addition to the guidance they provide (I'm wondering if any of the Economic Tax Stimulus checks made it over to Dell...).

A quick check of the IV chart shows that Dell has increased over the past month, but only 6-7 points from a low of around 31% to today's 36.31%: (look at the yellow line)

Let's take a look at the Jun 22 straddle (stock is closed today at $21.69). The EOD mark is 1.675, here are the Greeks:

Delta: -6.97 - small, as expected from a straddle this near the money
Theta: -3.59 - not too high, which is nice, but we wouldn't care since this would be such a short-term play
Vega: 4.42 - small again, this coincides with what we are seeing in the ADBE straddles--that farther-out straddles have higher Vega

Basically, we are hoping for a big move in the stock, that will hopefully overcome the volatility crush which is likely to be 6-7 points again--back to pre Earnings IV run-up. Using the thinkorswim analysis tools to factor in a 7 point drop in IV, as well as a $2 change in stock price (~9%) the value of the straddle would be worth 2.01 (we would buy it for 1.675).

Tomorrow morning (May 29) I will place an order to buy 1 DELL Jun 22 Straddle. Hopefully earnings/guidance will move the stock enough to overcome the impending drop in IV.

Cheers.

Day 2 - Volatility on the rebound

Today was a good day for all four straddles. If you remember, I was interested in positioning an ATM straddle (strike: 42.5) on Adobe as it nears the next Earnings Announcement (June 20). In an attempt to better understand the intricacies of a straddle, I have placed 4 straddle trades—each at a different Expiration month, all on the 42.5 strike price.

The reasoning behind using different expirations was that the Greeks for the farther-out options were a lot more attractive. Since a straddle suffers from Time Decay, and gains from Implied Volatility increases (and delta if it moves significantly—but this is more of a Volatility play) we want a low Theta and a high Vega. What I discovered was that farther-out options had a lower Theta and higher Vega than nearer-term.


Analysis
I believe the reason for all four straddles increasing was due mainly to delta. For reference, the underlying increased .85 today (2%). Here is a table of the deltas from the opening of the positions (May 27) through EOD today (May 29):

You will see that each straddle’s delta has turned positive. Since I am unable to track this throughout the day we can hypothesize that somewhere over the course of the day while the stock was increasing 2% the straddles gained in their positive delta to end the day at the deltas in the above chart.

Additionally, Implied Volatility has increased almost 100 basis points to 35.1% (IV Mean). The spreadsheet below shows the Vega for each straddle, and as you will see we have positive Vega so the rise in IV will increase the Theoretical Price of the option.

In summary, the 2% move in ADBE combined with the increase in IV translated into the following gains:
Jun 08 Straddle - +$5.00
Jul 08 Straddle +$12.50
Oct 08 42.5 Straddle +$ 5.00
Jan 09 42.5 Straddle +$15.00

Should we be excited about the increase due to the underlying’s movement? Well it does help us out right now, but I do not care if the stock dropped back down to $42.50 (where the straddles would reach max loss at expiration) simply because our goal is to capture increasing volatility (any delta benefit is extra gravy). The better part of today’s activity is that volatility increased from when we opened the trade and that is what I will be watching as the earnings announcement draws closer.

Cheers.

Update 1 - Adobe Volatility Straddle

I had placed the orders for the 4 straddles as discussed in my previous post here over the weekend, and as such, the fills were taken this morning. I will attempt to provide daily updates on the positions as I analyze and try to figure out what's affecting the positions. Here is the current P&L:

As you can see, all of the straddles are down a few dollars except for the farthest out expiration in Jan 09. I have added the greeks to this spreadsheet in order to track their day-to-day changes as well as the positions' values.

Analysis
Looking at the front month's straddle, you can see it has lost .21 (or $21 per contract). We will look to the greeks in an attempt to understand what could have caused this.

First of all you can see that the position had an original Delta of -11.90
(these greeks are per 100, so the -11.90 would represent an actual $11.90 loss
if the stock moved up $1.00 per share, said another way, the contract had a
-0.1190 delta). Given that the stock increased 74 cents today, I would say that you would expect to realize 74% of that -11.90 Delta, which equates to $-8.81.

Additionally, the opening Theta of -5.28 now needs to be realized in the
option price, which would lower the contract .0528 ($5.28 hit to our P/L).

Unfortunately I did not record each position's opening Implied Volatility so we cannot analyze the Vega effect on the positions. However, for the sake of analysis, we can use the stock's Mean Implied Volatility (this will be the IV calculated as an average of all Strike Prices' Imp Vol's.). The overall IV of ADBE decreased by .27% points. The Jun 08 straddle had a Vega of 9.02 and -27% of this is -$2.44.

Let's add these together:

Delta Effect + Theta Effect + Vega Effect

-8.81 + -5.28 + -2.44 = -$16.53

In reality the Jun Straddle went down $21.00, some of that difference may be due to the fact that we were using the Mean IV of all options as opposed to the 42.5 strikes' IV. The other--potentially greater--issue here is that we are using an Option Pricing Model (the Bjerksend-Stensland,specifcally) and it would be dangerously naive of us to place our full trust in a model. With that said, I'm quite pleased at how much of the $21 loss were able to "explain" or at least somewhat quantify. I'm begnning to see the importance of the Greeks more and more.

Cheers.

Dive in. Volatility Straddle

I like this one. Given that there are three main components to option pricing and theory (time, underlying, and volatility (Theta, Delta, and Vega for the smarter ones out there)), this trade focuses on volatility and hopes to capture a rise in said component. As such, I call this a "Volatility Straddle" (it should be noted there is no difference between this and a normal straddle, just sounds cooler).

As you can see in the attached image, Adobe appears to have a run-up in Implied Volatility (IV) going into earnings release dates. The red arrows show the increasing levels of IV. The next earnings release is scheduled for after market close June 16, 2008 (20 days from May 27—when markets open again). So far, looking at the chart, IV appears to be relatively low and has not experienced a run-up. If Adobe follows the pattern as it has in the past, we can anticipate a similar run-up in IV. The Volatility Straddle should profitably exploit this.

Target: ADBE
Expiration: June 20, 2008
Earnings: June 16, 2008
Stock
Price: $41.25

Strategy: Buy Jun 42.5 Straddle
Call Mark: $1.10
Put Mark: $2.25
Net Debit: $3.35
Max
Duration: 20 Days (anytime during
June 16, as earnings are released AMC)

Let's now attempt to analyze this trade. Anytime you buy an option, you will have negative theta (each passing day will hurt you). This position has a negative theta of 5.28 (with one contract we expect the position to lose $5.28 a day due to time decay). Vega is positive 9.02, meaning for each 1.0 percentage point (100 basis points) increase we gain $9.02. Vega is the greek that lends itself to this strategy. Because we anticipate an increase of IV (I'm hoping for at least a 10 point increase) we want to be positive Vega. The final greek, Delta (I don't understand Gamma, so I will ignore it until I have a decent understanding of it), is -11.90, so we lose $12 for each $1 increase in the stock price. This is the part that confuses me the most. The goal of a straddle is to be delta-neutral, this is not always possible, and while this position has what is considered a tiny delta, It is odd to me that if the stock goes up a $1, we lose $12 because I know that if the stock were to go up, say $10 a share, this straddle would increase significantly in value. (I have a hunch Gamma would help explain some of this...)

Moving on, here are the Greeks for a few more farther out expirations for comparison's sake:

What I find interesting here is that all of these trades look a lot more attractive based off the greeks. The Jan 2009 expiration has a smaller Theta and significantly higher Vega. Other than having to shell out more cash for that option ($880 vs $335 for the Jun exp.), I see no reason why that shouldn't be the expiration this trade uses. For observations sake I will place a paper trade for all four expirations in hopes of better understanding this.

Cheers.

In The Beginning

This is where it starts. Over the past 2'ish years I have been fascinated, angered, excited, but mostly confused by options. Yes, there is a lot more to an option than what a corporation grants its directors. Did you know you can buy or sell those same options? And that's just the beginning. I suppose the logical progression of an option trader (not that I am one) begins with the basic understanding of obtaining the right to purchase securities in the future at a predetermined price. It does not take a rocket scientist to understand that if you bought an option to purchase Visa (currently trading in the $80's) stock at $100 a share in 6 months for only 10 cents, you would be quite happy if at that time Visa has moved to $120. So if you understand that, good. While I am by no means qualified (zero experience, zero training) to discuss anything other than the very basics of option strategy and theory, I will attempt do just that.

Cheers,

Chad