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Earnings Trade

We picked Pepsico (PEP) from our watchlist at dgroeschke.com to play with for our earnings trade. Pepsico earnings announcement is on July 10, 2018 market open.

Planning

On July 9, 2017 before market close, I chanced upon Option Chains of Pepsico and decided for an earnings trade with no big price change expectations. Normally I love straddles or strangles since it gives much credit and hence air for the price to move – allowing me to come above Breakeven. But I´ve taken snapshots after my trade got filled to show you just why I opted for a calendar spread this time.

Choice one is opening a calendar spread. Here you are choosing to spend around 20 bucks for a max potential profit around 100 come July 13 (expiry of the front option) as shown in this pic. There is no margin held by the broker. Worse comes to worse you lose your initial investment 20 and no more. Should you get called on the front expiring option, you can opt to exercise the back week option bought.

put calendar spread

Choice two was selling a straddle. Straddles, are great sources of credit specially when IV is high. I decided against it this time since with a straddles I expect to buy them back and one of the sold options will always be losing – either the call or the put. Good cases is when you get to close the whole order for around half the price. in this case if you get filled at 265 USD, you expect a profit around 130 on a very good scenario.

Margin requirements are also bigger depending on underlying price since by selling options you are required to be able to fullfill the promises or insurance you sold the option buyer. And this is the last straw that led me to put 20 for a calendar this time on the table. Notice the Breakeven Point (BEP) of pic 1 and pic 2 are the same. I don´t see any reason for tying up more money to earn more or less the same and have the same BEPs.

straddle Profit and Loss chart

The Strategy

So here we are getting us filled on a put calendar spread via the following order seen below:

put calendar spread order

The order below involves selling call options with the 109 strike allowing us to use the credit to purchase the back week option (1 week back) and bank on 3 things:

  1. The IV crush of the front dated option: IV of the options nearest to earnings are much higher than the normal IV of the back period option chain. This bloats the pricing of the front week option. Once IV normalizes after earnings, provided the price stays more or less the same, the credit you sold has a lower buyback price therefore making the combo more expensive and while your back week option stays more or less the same value (provided with the same assumption that price does not move much), you can sell back to the market your combo for a more expensive price than you paid for.
  2. Theta on the front week is more than the back weeks. In short if price doesn´t move materially, you get the difference of the front theta minus back week theta per day.
  3. Net debit strategy. No Margin required. Max loss is debit paid- 16 USD in my case plus 1.24 commission. Goal is to sell for more $$$.

Option chain snapshots provided for reference in case you guys get curious.

option chains option chain

The Risk

My risk in this debit strategy is the price I pay for the combo since it is perfectly hedged with the back week option. As mentioned above, I got filled for 16 USD debit with comissions of 1.24 USD. Most I will ever lose is 17.24.

Calendar Spread

For details, see also Pepsico Investor Relations Page.

The Risk

On July 10 market open midprice was around 30 and I took the risk to wait for a comeback somewhere near the 109 level. This did not happen and what would have been a net profit was booked a loss by the close of this transaction. This trade was closed at a loss of selling the long leg after expiry of the sold put. Long put sold for 8 with fees of 1.09. Net loss was 10.33 USD.

Our Watchlist

Our watchlist is programmed to reflect the relative IV of options. This automates the task of detecting option pricing advantages or disadvantages due to relative volatility. – thus allowing us to focus more on the creative part of the task – planning and strategics on trades that come on to our radar with the help of our watchlist. Should you be interested to use our watchlist, you can try it out for a month to month basis for 1,99 USD – with no long term payment obligation – this means that the subscription is cancelable any month you decide you don`t want to use the watchlist anymore. Here´s a screenshot of the watchlist as of September 25, 2017 that helped me pick out Pepsico.

 

Additional Risk Disclosure
Trading as is already exposes you to a material amount of risk and can cause material losses, even exceeding your initial investment. In addition, trading with margin and trading on or before earnings announcements increases that risk even more.

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