FB earnings strangle

Discussion in 'Options' started by qlai, Oct 22, 2021.

  1. qlai


    @W-M-A, I guess I am not understanding why would you need to do calendar spread and hedge with shares. Isn’t long leg of the spread done for protection? Sound like you are doing dynamic hedging of sorts. Maybe you can walk us through a hypothetical trade?
    #11     Oct 23, 2021
  2. W-M-A


    Hey, you understand it correctly in terms of the dynamic hedging, and the fundamental basis of calendar spread as a so-called risk-defined strategy where the long leg with longer maturity absorbs the impact of the short, short-dated leg.

    The whole premise of this setup is that you are anticipating a move in the underlying of a magnitude that will not push the underlying deep, deep in the money. Because in such a case, only the very, very long-dated options will have Theta worth enough to differ one week's value from the next, and even that very insignificantly.

    For the short expiry, the Theta almost vanishes entirely. A deep in the money option expiring today will be priced the same as the one expiring one week from today, provided there is no volatility event lingering. But if the move is "moderate," say the underlying stays right at the money or slightly in the money. The longer-dated option will still have value and Theta worth to push the value of the spread higher once the value of the short-dated leg comes off the spread post expiry of the shorted leg.

    If you are quantitatively inclined, I can refer you to some sensitivity analysis and why this relationship holds via the derivations.

    For the hypothetical example: I open a short position on an option expiring tomorrow and a long position with the same strike expiring one week from tomorrow. We have a volatility event overnight an anticipated event, such as an earnings report and the underlying breaches the strike and moves deep in the money, now any premium that I had paid for entering the spread will be lost as both the options will be priced equally unless the volatility event is not anticipated in which case the vega of the longer-dated option will be higher. The sudden volatility increase will have a positive effect on the longer-dated option. However, since we know that the volatility event is anticipated and post the event volatility will subside, and we can be sure of losing the premiums paid. Since I don't want to lose my premium just because the move was larger than I anticipated initially, I enter the "pseudo hedging" activity by selling/buying in the direction of the underlying.

    So Thank you for making me think about this in a sense to have to explain it. In the process, I came up with the term pseudo hedging, as the position itself is already hedged. Still, this additional activity is related to saving the premiums and gaining from the trade :).
    #12     Oct 23, 2021
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  3. GotherL


    These premiums are whacked leading up to earnings.

    Selling 340-350 calls = profit. (I do not know the correct term since I don't have access to level 3 or higher..)
    Last edited: Oct 23, 2021
    #13     Oct 23, 2021
  4. traider


    Are you able to share a bit on how to do optimal hedging?
    #14     Oct 23, 2021
  5. So... you've been assigned at a loss - a relatively large one, since you couldn't roll out from under it - and now you're going to sell puts (ATM, I presume?) while being short the stock (unlimited risk with zero protection.) And while you've got that amount tied up and not earning anything for you, you're going to risk that much again in the hope that it goes down (not very rewarding, since you'll be losing a large and increasing part of what you gain via that short put.) Sounds like an unnecessarily complicated version of the martingale strategy... I'm not sure how this is supposed to make sense.
    #15     Oct 23, 2021
  6. qlai


    Sorry, maybe I didn’t explain it correctly. You know the wheel: sell cash secured put, get assigned long shares, sell covered calls.

    So you can do the same on the short side: sell naked calls, get assigned short shares(at price you don’t mind being short), sell covered puts. I would sell puts below my cost basis or just hold the short stock waiting for a drop.

    Does that make sense technically, not ROI or risk wise? Obviously, I am hoping NOT to get assigned on either side with posted trade.
    #16     Oct 23, 2021
  7. Nope; doesn't make sense. With the wheel, you only take stock when you can no longer roll your put out or down for a credit - and when you're assigned a long position in it, you sell calls to make up the loss. The problem is that bit about "at price you don’t mind being short": if you had that choice, you'd never bother taking the stock! In fact, you can take this as part of the definition of wheeling: you will always "mind" the price at which you're assigned, since it's going to be a significant loss.

    But the difference is that, when you're long, you own something that is loss-capped (and, if you're smart, it's in a ticker that has high volume/liquidity and good growth prospects); given the fact that a company worth hundreds of billions of dollars isn't going to evaporate tomorrow and the positive drift of the market, it's very likely to cooperate with your thesis (price going up) over time. This supports the premise of short puts and covered calls.

    When you're short the stock, you're not loss-capped - and the long-term market forces are now working against you, as is volatility (which normally helps you): as the price goes up, not only do you lose on the stock, but also on the premium. As price goes up, vol goes down... and so does the premium. Your only hope is for the price to drop - but not too far, since you'll be losing money on the short put at an accelerating rate as it goes deeper ITM (and at 100D, you'll be losing the same amount on it that you gain on your short stock position.)

    If you sell puts below your cost basis, then you're hosing yourself even more - since, as soon as you get put that new stock, you'll capture the loss between spot at the first assignment and the put strike in addition to the (large) loss you've already taken. And that's all aside from the unlimited risk you're holding by being short this active growth stock in a market with positive drift. I can't think of too many positions worse than that.
    #17     Oct 23, 2021
  8. qlai


    Ok, so I think that you are more knowledgeable with the options than me, so below is just my points of view, not an argument against what you said.

    That is a good strategy, but usually is not what is advertised to retail. The guys that I watched all say: we want to get assigned long shares. None (except one) suggested trying to avoid assignment.
    Yes, generally all correct. However, I would say that the short term, FB has same chance to sell off 10% as go up same. I think it’s kind of a myth fed to us, retailers, that longing stocks is “safer.” As we all know, hedge funds love shorting the hell out of stocks.

    Sorry, you lost me here. Let’s say I get assigned my 350 and the stock is at 355, so I sell put at 345. As you know, puts sell at higher premiums than equidistant calls. So if price drops below 345, I capture both premium plus gains on the stock. Not different than covered calls, no?

    It seems to me that your thinking is heavily biased to the long side. Longer term, I am with you, but I’m trading weeklies here and, even if assigned, hope to get out within months.

    I appreciate your input!
    #18     Oct 23, 2021
  9. destriero


    I have 700 combo swaps on the name. I'll let you know how it goes.
    #19     Oct 23, 2021
  10. qlai


    I don’t know what that means, but I hope I am not on the other side of your trades, lol
    #20     Oct 23, 2021
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