New Earnings Trade

• stevenplace
• January 21st, 2010

We’re going to be selling vol in GOOG earnings, but first let’s get some analysis out of the way.

On the technical landscape, it seems that the predominant uptrend has broken. We are below the 20 and 50 day moving averages, and a significant trendline has been broken. However, that does not mean we are in a downtrend; rather we will see some consolidation and distribution as shares change hands– that is evident from the volume pickup over the past 15 trading days.

We have very clear technical support and resistance levels at 560 and 630, and we could see price action similar to what AMZN put in since November.

So what is the perceived risk in the options market?

Today’s order flow does not signifiy any sort of strong move coming up. The volume is slightly higher than average, but there are no extreme bid/ask trades– that’s partially due to the large difference between bid/ask.

We’re currently seeing a large bidup in implied volatility– that means traders and investors are paying up for protection into the move. The last time we had a strong implied vol was last time around earnings in October, and we saw an IV crush of about 10%.

Next, let’s look at what an ATM straddle is selling for:

Feb 580 Straddle: 46.30

Price/Strike: 8%

Now if we were to see a 10% drop in implied volatilty, what move would we need to see to be in a winning position?

Our breakevens would then have a price between about 540 and 616– I have a feeling that given this volatility environment, we won’t see a move like that.

However, I don’t want to be fully exposed to the downside, so we may want to consider different strategies.

Here’s the volatility skew:

So it may make more sense to look at selling further OTM strikes on puts. So a bull put spread makes sense, but since our upside risk is limited, we can finance that risk by a bear call spread, thereby getting into an iron condor.

SELL -2 IRON CONDOR GOOG 100 FEB 10 630/640/530/520 CALL/PUT @3.35 LMT

All voll risk aside, this trade makes money as long as GOOG stays within 527-633 by Feb opex.

Risk: 1320

Return: 680

RoR: 51.5

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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