We picked Square Inc. (NYSE: SQ) from our watchlist at dgroeschke.com to play with for our earnings trade. Square earnings announcement is on November 8, 2017 market close.
On November 8, 2017 we decided to open a call calendar spread via the following order seen below:
The order below involves selling call options with the 37 strike and using the credit to purchase the back week option (2 weeks back) and bank on 3 things:
- 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.
- Theta on the front week is much 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. That´s more or less 33.70 USD (39.9 – 6.20)
- Net debit strategy. No Margin required. Need I say more?
My risk in this debit strategy is the price I pay for the combo since it is perfectly hedged with the back week option. In this case since I got filled for 24 USD debit with comissions of 0,25 USD. Most I will ever lose is 24,25.
Let´s see what market open holds.. 🙂
For details, see also SQ Inc. Home Page.
SQ initially slumped and there was no bid ask for the 37 strike call options for the back week when it slid to 35.05 so I seperated the legs by eliminating first the short leg, paying 10 USD with 0.34 USD commissions, then selling the long leg for 50 with 0.34 USD cost. Eventually SQ went back to almost 39 on 16:27 and I would have sold the back week for more but my net profit on the invested 24.25 initial cost is 15.07*. 62% of invested capital with 24.25 USD downside risk.
*15.07 = 24+0.25+10+0.34-50+0.34
Screenshots of related option chains few minutes after closing out as follows:
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 Square.
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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