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Straddle Option Price Useful For Earnings Move Estimates

Even if you don’t trade options, there are some valuable options metrics you can use for your stock analysis. Earlier in the week, we introduced the concept of a stock’s expected return using the option price of an at-the-money straddle option. With the earnings reports flooding in this week, it’s useful to know the expected move to determine whether you will hold a stock through earnings.




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Straddle Option Price Isn’t Just For Option Traders

As a reminder, we calculate the expected return by adding together the price of the at-the-money put option and the at-the-money call option. This is known as the at-the-money straddle.

You can always put the expected move in percentage terms. Just take the at-the-money straddle price and divide it by the stock’s current price. And remember, this is a move that could be either up or down from the current price.

How could this help your stock trading? If you already have a profit cushion on a stock and earnings are looming, this helps inform your decision on whether to hold through earnings. Look at the case if your stock drops by the amount of expected return. Would you be able to handle that for the individual stock and for your portfolio?

Expected Return Calculations: GM Stock

Let’s take a look at some more examples of using the at-the-money straddle to calculate expected return.

General Motors (GM) reports earnings on Wed. May 5. If we look at GM stock options expiring on May 7, we see that the 58 call is trading around 2.00 and the 58 put is trading at 1.40.

Adding the two together gives us a straddle price of 3.40. So, we know that the option market thinks GM stock will move up or down by 3.40 between now and May 7. That translates to roughly a 5.9% move either way. Of course, the earnings report is most likely a big factor in that.

The lower range can be calculated by taking the stock price of 57.70 and subtracting the straddle price of 3.40 to give 54.30.

The upper range will be 57.70 plus 3.40 to give 61.10.

Nobody can predict the future, but this gives us an estimate of what market makers think will be the range for GM stock following earnings.

How Did They Do?

Let’s look at some other recent examples and how well the straddle worked in estimating the move.

First, let’s look at Tesla (TSLA). For the last five quarters, TSLA stock has stayed within the expected range. If your decision to hold was based on how much Tesla might drop, you weren’t caught off guard by any of the moves down.

TLSA Earnings Moves
Release Date Expected Range Actual Move
4/29/2020 10.9% -2.3%
7/22/2020 13.5 5.0
10/21/2020 8.3 0.8
1/27/2021 8.9 -3.3
4/26/2021 7.5 -4.5

Let’s look at Microsoft (MSFT) as well. Microsoft stock moved more than the straddle price estimated once out of the last five reports, in Oct. 2020. The July 2020 came in right at the level of the expected move. Yes it was down, but remember the expected move is plus or minus.

MSFT Earnings Moves
Release Date Expected Range Actual Move
4/29/2020 4.8% 1.0%
7/22/2020 4.4 -4.4
10/27/2020 4.5 -5.0
1/26/2021 4.9 0.3
4/27/2021 3.2 -2.8

Finally, let’s look at Amazon (AMZN) with their report due today. Amazon stock saw three out of the last five moves greater than the expected range. It’s a reminder that the straddle price isn’t a perfect predictor. Just a good estimate.

AMZN Earnings Moves
Release Date Expected Range Actual Move
1/30/2020 3.6% 7.4%
4/30/2020 5.5 -7.6
7/30/2020 5.1 3.7
10/29/2020 4.7 -5.5
2/2/2021 5.0 -2.0

Ahead of the earnings report, the options market priced in a roughly 135 point move in AMZN stock after earnings, or 3.9%. We’ll see how it opens up tomorrow. In the meantime, look at the April 30 option chain using today’s closing option prices and see if you can calculate it yourself. It’s good practice.

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

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