We're right in the thick of earnings season with results coming in daily for key companies in the S&P 500. While it can be a risky time for option traders, there is also a lot of opportunity including a strategy for Goldman Sachs stock.
One popular trade among option traders is a short straddle that is held over the earnings announcement. This is a risky trade because it involves the sale of naked options, so it is not recommended for beginners. The losses are potentially unlimited so always keep that in mind.
Goldman Sachs reports earnings Wednesday before the opening bell, so I thought it would be interesting to look at a short straddle option trade.
Specifically, we'll look at a short straddle with an Oct. 16 expiration date.
To set up a short straddle, traders would sell the at-the-money call and the at-the-money put. Goldman Sachs closed just above 214 on Monday, so the at-the-money strike would be at 215.
At the close of trade on Monday, the 215 call was trading around $3.85 and the 215 put was trading for $4.70. Selling these two options would generate $855 in premium with break-even points at $206.45 and $223.55.
Market makers set option prices based on an expected move over the life of an option. Currently the implied move for Goldman Sachs stock over earnings is around 4%.
This is calculated as the premium of $8.55 divided by the stock price of $214.12. It also means Goldman Sachs stock can move up or down by 4% before the trade starts to suffer losses.
The last six times Goldman Sachs reported earnings, the stock price remained within the expected range.
There's no guarantee of course that the stock will stay within the expected move again this time.
If the move is less than 4%, the straddle sellers win. If the move is more than that, the straddle buyers win.
Selling straddles over earnings is a popular trade for option traders; however it's important to be aware of the risks when trading naked options.
It's important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
