We closed six trades across our services last week, five of which were winners. Those winners generated $910 in profits. However, the large loss we took on the Amazon (AMZN) pre-earnings straddle in the 5K Challenge program left us net negative for the week.
Here are all the closed trades from the week of May 5-9:
We entered the AMZN straddle trade on the morning of May 1. Amazon was due to report earnings after the close that day, along with fellow Magnificent 7 stock Apple (AAPL).
Option traders often like to trade straddles ahead of earnings announcements for a number of reasons:
Anticipation of high volatility: Earnings reports are typically significant events that can cause a stock’s price to move substantially in either direction, depending on whether the announced results and future guidance beat, meet or miss market expectations. Straddles, which involve buying both a call and a put option with the same strike price and expiration date, are designed to profit from large price swings, regardless of the direction.
Capturing implied volatility expansion: Leading up to an earnings announcement, the implied volatility (IV) of a stock’s options often increases. This is because there’s greater uncertainty about the future price movement. Buying a straddle before this IV expansion can allow traders to potentially profit as the value of both the call and put options increases with the rise in IV.
Directional agnosticism: With a straddle, the trader doesn’t need to predict whether the stock price will go up or down. As long as the price moves significantly in either direction beyond the combined premiums paid for the call and put, the straddle can be profitable.
Defined risk: The maximum loss for a long straddle is limited to the total premium paid for buying both options. This defined risk makes it an attractive strategy for traders who want to capitalize on potential volatility without the unlimited risk associated with short option strategies or outright stock positions.
Potential for high reward: If the stock price makes a large enough move after the earnings announcement, the profit potential on a straddle can be substantial, potentially exceeding the initial cost of the trade multiple times.
However, there are also risks associated with trading straddles before earnings, namely:
Time decay (theta): Options lose value as they get closer to their expiration date. If the stock price doesn’t move significantly before expiration, the value of both the call and put can erode due to time decay, leading to a loss.
Volatility crush: After the earnings announcement, the uncertainty surrounding the stock typically decreases, leading to a sharp decline in implied volatility, known as “volatility crush.” This can negatively impact the value of the straddle, even if the stock price moves, potentially offsetting some or all of the gains from the price movement.
Cost of the straddle: Option premiums tend to be higher in the lead-up to earnings due to the increased implied volatility. This higher cost increases the magnitude of the price move required for the straddle to become profitable.
In summary, option traders like to trade straddles ahead of earnings as a way to capitalize on the anticipated increase in volatility and the potential for a significant price move in either direction, with a defined maximum risk. However, they must also be mindful of time decay and the potential for a volatility crush after the earnings are released.
Amazon delivered solid first-quarter results on May 1.Net sales increased 9% year over year to $155.7 billion, and 10% excluding the impact of unfavorable foreign exchange rates. This was better than the consensus estimate of around $155.1 billion.
Operating income showed significant improvement, rising more than 20% from the same period last year to $18.4 billion. And adjusted EPS came in at $1.59, significantly beating estimates.
But Amazon’s guidance for the second quarter came in light, with the company citing uncertainty surrounding tariffs as a significant factor for its conservative operating income guidance. While management said they hadn’t yet seen a slowdown in demand, they acknowledged the potential for pricing impacts if tariffs were to escalate.
Following the announcement, AMZN stock initially experienced a slight downturn in after-hours trading. But the dip didn’t translate into a prolonged sell-off, and the stock recovered into Friday’s close.
Part of the reason for this could be that many analysts maintained their “buy” ratings for Amazon despite the cautious Q2 guidance and tariff concerns. And their price targets generally remained well above the prevailing stock price.
While the stock showed some volatility in subsequent days, it generally traded within a range and did not experience a significant or sustained downward or upward trend.
And therein lies the problem for our AMZN straddle, which had a May 9 expiration date and a 190 strike price. We paid $14 to enter the trade, meaning the breakeven points for this straddle were $204 on the upside ($190+$14) and $176 on the downside ($190-$14). At the time, the expected one-day move was 14 points in either direction, making for a nice setup.
Yet, while Amazon’s stock price did move after earnings, the total move of $10.84 ($194.69 post-earnings high – $183.85 low) by the expiration date was not large enough to overcome the initial cost (the net debit of $14) of the straddle.
As the May 9 expiration approached, the time value of both the put and call options eroded, further contributing to the loss. The call option gained intrinsic value, but it wasn’t enough to offset the initial cost and the decay of the put option.
Rather than watch the rest of the value erode, we closed the position on May 8 for a credit of $3.60, booking a loss of $1,040 per contract, and $2,080 total on the two contracts we traded in the live account.
This was obviously not the desired outcome. However, we noted at the time we entered the straddle that this was a high-risk trade that hinged on AMZN making at least its expected move following earnings.
Unfortunately, sometimes things don’t pan out. And while we’ve found success with straddles before, this was not one of those times.
Before we sign off, in the previous Weekly Income Report, we discussed the upcoming Millionaire’s Trading Club event that will feature three days of virtual trading May 13-15.
Last week, we closed the final trade from the April 25 Millionaire’s Trading Club VIP Live Trading Session – the Global X Silver Miners ETF (SIL) poor man’s covered call. From those four positions, we pocketed more than $1,000 in the live account in just two weeks.
This bodes well for our $2,500 income goal we are targeting for the three-day virtual event this week. If you’ve yet to secure your spot, there is still time.
