Straddle into financial news; looking for input

[XOM]

I'm researching this as a strategy and would appreciate some experience based input on this. Specifically I am looking into a straddle on PGR which reports it's monthly financials on 4/9 bmo. I think the numbers will be as negative as last months, however nothing is guaranteed, hence the straddle vs buying puts.

So it appears that if I am more downside biased then I should choose the strike just above the current pps of $16.33 which would be the 17.50 strike and if I were more upside biased then I should choose the 15 strike. Which brings the first question; is this just a result of this stock at this price in between strikes with it's level of volatility or is this a common thing to see when looking at straddles?

I'd rather have equal up/down risk I'm just not sure that it's possible. Anyway, in this case if I took the AUG08 17.50 straddle I would need to see the pps move up by $1.50 or stay flat to break even (not including fees). Any downside movement would provide immediate profit and anything above $17.93 in the underlying would generate profit.

These projections are based on pps movement and time decay and current volatility on 4/9. How would one adjust for calculated change in volatility? Which way does the volatilty move in relation to direction of pps and to what degree? Or is this less meaningful on stocks that have relatively low volatility to begin with?

Would it be better to use a strike with more or less days to expiration? I figured that if the financial data has no significant impact I would at least have some time to wait for a move significant enough to exit the trade in the green, albeit at the expense of losing to time decay in the process.

I'm probably missing some aspect that is important in calculating the possibilities of this trade, some analytical input would be appreciated.

I'm really interested in this from an options standpoint but for what it's worth on a fundamental basis, here's a link to last month's financial data release by PGR which caused a nice gap down last month;

http://investors.progressive.com/pdf/mreport-0208.pdf

The stock has been getting hammered for a long time now, their last effort at reinventing themselves has failed miserably and cost them millions, employee moral is absolutely terrible, they are laying off or firing tenured employees. The current CEO has done nothing since riding the coat tails of the former and successful CEO Peter B. Lewis. Basically, they are in trouble and losing market share.

[netwrangler]

The problem with Straddles and Strangles is that the market makers are betting against you.

So, if you are going to win, you need to have an edge — something that you know [or are willing to bet on] that has not been factored into the 'market'.
Hard to do, but it can be done.

Another way to make it work is by 'legging in'.

When the stock is 'up' you buy the put.
When the stock is 'down' you buy the call.

Legging in is an effective way to counteract the 'spread'.
Of course, if you know enough to 'leg in', you know enough to go after a variety of trading strategies.

[XOM]

I'm not sure I follow you; if there is news that causes the underlying to move significantly, how can the options not move accordingly? Or are you just saying that the risk/reward is not optimal?

Legging in sounds good in theory, but my immediate concern is that more time is needed to prepare the trade which makes the issue of pps movement and volatiity more difficult to judge. In my proposed trade I'm looking at a buy today and closing out on Wednesday unless the trade is not generating a profit, in which case legging out might be a decent option?

[pedrom727]

I assume net is talking about the fact that the implied volatility is already factored into the premium price, which makes it pretty hard to get a substantial move sufficient to cover the cost of both premiums within the given timespan since the market is already anticipating fluctuations (this is assuming you buy both options at the same time of course). Going into bank earnings next week I'd personally be more content with a substantial sized put spread, that way you can lower your premium price although obviously you will not be able to take advantage of a pop, however, after the amount these stocks have run I'd be much more content putting on a cheap to execute put spread. A straddle could work, but if you're looking very immediate term you probably will not be able to buy cheap call options since they are so hot right now.

[XOM]

Well I decided to just run this one as a simulated trade for testing purposes. I guess I'll enter the results here so we can see how it goes and perhaps the experienced options traders can point out anything that they may think useful in planning other smilar trades.

So I entered a limit order for 10 calls/puts at the ask of $2.92 for the AUG08 $17.50 straddle just before market open and it was filled a few minutes into trading @ $2.86. At market close today the trade is showing a loss of $35, the total loss including comission is $75. (flat fee option might have been better, but probably would not have gotten the better fill which was worth $60)

Just as a quick recap; monthly financials statement for March will be released on Wednesday bmo, that is the target date for profit on this trade. If there is not sufficient movement in the underlying the plan will be to leg out of the trade before expiration.

[netwrangler]

I assume net is talking about the fact that the implied volatility is already factored into the premium price, which makes it pretty hard to get a substantial move sufficient to cover the cost of both premiums within the given timespan since the market is already anticipating fluctuations (this is assuming you buy both options at the same time of course). Going into bank earnings next week I'd personally be more content with a substantial sized put spread, that way you can lower your premium price although obviously you will not be able to take advantage of a pop, however, after the amount these stocks have run I'd be much more content putting on a cheap to execute put spread. A straddle could work, but if you're looking very immediate term you probably will not be able to buy cheap call options since they are so hot right now.
Thanks for jumping in there while I was traveling today, pedrom727. I couldn't have explained it better.

I'm interested in how you would [or do] structure a put spread. I'm pretty much out of trading and into being a grampa this week. Nevertheless, I'll be an interested spectator. If you have the time, I'd love to see the spread details.

[XOM]

Update on the simulated trade; up $75 today, current unrealized profit = $40.

Tomorrow will show whether this would have been a good or poor trade, a bit of a catch 22 for me; I have several relatives that work for the company and they have watched their 401ks shrink due to mismanagement (although I did opine to them to sell the PGR portion of their portfolios back at $21)

[pedrom727]

In the case of a put spread I'd probably do something like selling the $24 put and buying the $26 (using the XLF as an example here), this gives you limited profits should the stock/etf go below $24, however. In the case of financial earnings I think you might be better off just buying a slightly out of the money put where you have unlimited gains should they tank, as it is a very likely possibility. It really depends on how much you are willing to risk on the premiums and how much benefit you want to have from a move down. Personally at these levels I'd be more content with risking a little bit more on the premium personally, but both strategies are viable.

[netwrangler]

In the case of a put spread I'd probably do something like selling the $24 put and buying the $26 (using the XLF as an example here), this gives you limited profits should the stock/etf go below $24, however. In the case of financial earnings I think you might be better off just buying a slightly out of the money put where you have unlimited gains should they tank, as it is a very likely possibility. It really depends on how much you are willing to risk on the premiums and how much benefit you want to have from a move down. Personally at these levels I'd be more content with risking a little bit more on the premium personally, but both strategies are viable.Thanks, Pedro.
I'm going to run some numbers on both approaches.

[XOM]

Response to the news was favorable and saw as much as a 4% increase in the underlying. Not enough movement to make any substantial profit on the straddle so I placed a limit sell for $2.96 just before noon and it was filled @ $2.97 Gross profit was $110 and net was $30 (simulated of course)

I still feel that this was a pretty low risk trade, and it may have been more profitable on a longer hold time but this stock tends to stay in a pretty tight range outside of news and time decay would be my main concern.

I'm interested to see if a stock such as RIMM into earnings would offer a better opportunity, I think I'll back test that one and see if I can learn anything from that.