Trade results better with Options: Shubham Agarwal

F&O Cues

It’s that time of the year again. We have corporate earnings lined up. This is both exciting and uncomfortable. Exciting because of volatility. Uncomfortable, because the announcement of results may just change the entire trend. This makes being on the wrong side hurt the most.

Options work best in times like these, but results bring their own set of challenges for Option trading as well. Let us understand how Result impacts the Option Premiums.

The Volatility input in Option Premium is the expected volatility; when there is an event around the corner, for example results, we do see this Expected Volatility input go higher.

This is because the announcement of results can massively change the price trajectory, hence it is justified to have higher Expected Volatility in Option Premium before the results.

It does not end here. There is a second impact also. Once the result is out, the unknown is known. This means now there will be normalcy with no surprise element left. Hence, the expected volatility will now come back down again to similar levels.

How does it Impact the Option Premiums though?

Option Premiums are directly corelated to the Expected Volatility input in Option Premium pricing. This means, Rise in Expected Volatility, Rise in Premium and Fall in Expected Volatility Fall in Premium.

It is not unusual to see that before the Results, the All-Option Premiums rise a lot despite of no great movement in stock. Similarly, right after results Premiums of all the Options Fall both Call & Put regardless of the direction of movement in stock.

We need to understand and account for this to trade results with confidence using Options. There are 3 ways to do it.

1.      Before the Results: Mostly the Premiums will be in a rising mode. It is advisable to be more on the Buy side because in this time space it will be difficult to make money out of Selling Options. Secondly, due to the boost from rising expected volatility, one may get away with small or no loss despite of Stop Loss in the underlying.

2.      During the Announcement: Result announcement could have a positive, negative or no impact. If you have a Call or a Put buy, 2 out of those 3 impacts will create a loss for you. On top of that the fall in expected volatility post result will be yet another negative impact of the Option premium.

a.      Either do not buy it and if you must treat the entire premium as loss.

b.      Be careful in Selling avoid Selling Options (without a Buy Position).

3.      Post Announcement: Post results the Expected Volatility and Premiums will be on its way down. So, avoid Buying Options. If you must, Buy Call/Put and Sell a Higher Call/ Lower Put simultaneously. This will limit volatility-related losses in premium of the Option bought.

These are some of the tips and tricks on trading Options during the result season. Knowing them is necessary so that we lose to the change in premium due to the change in expected volatility.

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