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Using a Triple Calendar Spread to Trade Google Earnings


Here, a review of some of the data that an options trader should consider prior to constructing an option trade in order to profit from this earnings event.

One of the most useful characteristics of options is their ability to control risk and achieve a high probability of success when trading impending earnings announcements.

Google (NASDAQ:GOOG) will announce third quarter earnings after the market closes on Thursday. It does not take a conspiracy theorist to recognize that the following day, Friday, is the last day to trade October options. Given this timing, options trades can be constructed with near surgical precision to reflect the trader's hypotheses regarding the price reaction to the earnings release.

I thought it would be helpful to review some of the data that an options trader should consider prior to constructing an option trade to profit from this event and to consider some other potential trades.

First, the recent history of stock price move on earnings release must be considered. The reaction of price over the last four quarterly releases has been +8%, +7%, +2% and +3% with the two lowest numbers correlating with the two most recent earnings releases.

The second factor to consider is the information embedded in the current pricing of the options chain. The easiest way to determine the aggregate opinion of the overall option market as it relates to the expected move following the earnings release is to calculate the value of the front month at-the-money straddle discounted by roughly 15%. It is important to recognize that this value is reflective of the anticipated magnitude of the move and gives no information whatsoever on the direction.

In the case of Google, closing prices on Monday with Google trading around $740 give a value of ($19.90+20.80)*0.85 = $34.60. This equates to roughly a 5% move or a projection with a 68% probability (1 standard deviation) that the price movement will be bounded within this range.

Option positions to trade earnings can be based on two general considerations: directional or non-directional. Directional based trades can be constructed using a variety of approaches, but MUST account for the collapse of implied volatility following earnings release.

To be blunt, this means that simply buying only puts or calls in the front month series is not putting probabilities on your side. Appropriate directional constructions would include vertical spreads, butterflies, and calendars. Each of these trades either mitigates or benefits from the inevitable collapse of implied volatility immediately following the earnings release.

Playing earnings directionally is a difficult game. Recent market history is replete with unanticipated earnings misses and unforeseen earnings blowouts. For those who wish to play these announcements directionally, I feel the major value of an options approach is to control risk crisply since there will inevitably be unpredicted and unpredictable price reactions.

My preference is to use strategies that are profitable over a wide range of prices. The potential constructions in this category include iron condors and double and triple calendars. Such trades do not deliver the overwhelming returns of a correct prediction of price direction, but over a large series of trades result in a high probability of success.
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No positions in stocks mentioned.
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