On Thursday’s PreMarket Prep broadcast, the hosts of the show discussed how traders can use weekly options pricing to calculate the expected move in a stock following an earnings report.
What Is A Straddle? A straddle is a two-sided options strategy that consists of the purchase of both a put and call option for the same expiration date and strike price on the same underlying security. The strategy will only be profitable when the stock either rises or falls from the strike price by more than the total premium paid.
Straddle Implies Expected Move: Although many traders and investors rely on technical analysis to predict or interpret price action, the fundamentals (earnings) are what truly move stocks in the long run.
With Tesla Inc (NASDAQ:TSLA)'s close of $937.41 Wednesday, the straddle price — which was calculated using the weekly options — came to approximately $90, which was found by combining the price of a $935 put and $935 call. In other words, if an investor was expecting a big move, but were unsure of the direction, they could have a market-neutral position for $90.
If an investor held both positions, the breakeven level was $1,025 on the upside and $845 on the downside. As of 2:35 p.m. EST with the issue trading at $842, the same straddle is trading around $90. As a result, if one had held both positions up to this point, they would be looking at no profit while taking on an exorbitant amount of risk.
Related Link: Tesla Falls On Q4 Earnings: 3 Analysts On What's Next For EV Stock
The Last Word: Options market makers are extremely sophisticated and use multiple data sets to determine the expected move in an issue following an earnings report.
While it is tempting to bet against them with strategies such as straddles, more times than not their predetermined pricing parameters are rarely exceeded.
The full discussion on this strategy from Thursday’s show can be found here:
