Over the last two days, Tom Sosnoff and Tony Battista have been discussing some compelling studies conducted by the tastytrade research team centered on selling premium around earnings. At tastytrade, we trade earnings with either a straddle (selling both the front month at-the-money call and put) or a strangle (selling both the front-month out-of-the-money call and put).
The tastytrade team lept into action after noticing a recent Barron's article by Steven M. Sears in which the author made public some studies by Goldman Sachs that suggested getting long premium (i.e buying the straddle) for earnings in stocks over $100 would produce positive returns -- this is counter to what we have found successful.
The particular quote in the article that really got tastytrade's engines revving was the following assertion, "The Goldman study found that buying straddles on stocks above $100 produced positive returns during 14 of 19 years and in five of the past eight quarters."
It was further noted in Mr. Sears article that, "A study of trading earnings since 1996 revealed that options on stocks above $100 were 'systematically underpriced' relative to the less expensive stocks."
Having conducted a truckload of similar studies in the past, the research team at tastytrade embarked on a quest to re-create the study from this article to produce their own findings.
Spanning two episodes of Market Measures, the July 14 and July 15 segments feature Tom and Tony discussing the results and comparing them to the assertions contained in the article by Mr. Sears at Barron's.
It should be noted that tastytrade only used data as far back as 2002 versus the Goldman study which is indicated to have stretched back to 1996. Another disclaimer that must be mentioned is that tastytrade obviously isn't privy to the exact parameters and assumptions used in the Goldman study.
For example, tastytrade set the mark of 500 contracts open interest as the minimum level of market activity in a symbol to consider it liquid enough to be included in the study. Additionally, tastytrade took a two-pronged approach - first a study that examined all stocks and then a study that specifically focused on stocks only above $100.
On the July 14 episode of Market Measures, Tom and Tony first highlighted the findings from the broader study, which encompassed getting long premium earnings for all stocks from 2002. As outlined in the Barron's article, the specific trade execution parameters dictate buying a straddle five days before earnings and closing the trade the day after earnings.
As Tom and Tony discuss on the segment, the tastytrade study revealed 529 stocks that fit the parameters (open interest greater than 500) which translated to 17,966 occurrences. tastytrade then back-tested the historical data through a model that bought the earnings straddle five days before earnings and closed out immediately following the announcement.
It should be emphasized here that the tastytrade study "closed out immediately following the announcement" whereas the study referenced in the article was "closing out the position the day after earnings."
Regardless of those subtle differences, the tastytrade study was completely unambiguous in its conclusions. As seen in the graphic below from the show, only 6,206 (35%) of occurrences were profitable, while 11,760 (65%) were not profitable:
As illustrated above, the takeaway from the study including all stocks (fitting the parameters) in a strategy buying the earnings straddle five days before the event and held through the announcement lost money in 65% of trades. Meaning, the strategy wasn't profitable, on average.
As observed on the July 15 episode of Market Measures, the results from the second study, focused only on earnings straddles in stocks above $100, weren't noticeably different.
In this episode, Tom and Tony delve into great detail about the assertions of the Goldman study, the findings of the nearly identical tastytrade study, and the inexplicable gap between the conclusions.
As a reminder, the Barron's article said, "The Goldman study found that buying straddles on stocks above $100 produced positive returns during 14 of 19 years and in five of the past eight quarters."
For this study, the tastytrade team found 158 stocks that met their criteria for selection which translated to a total of 955 trades (out of 17,966 in the broader study) from 2002 through present.
While the number of instances was greatly reduced, the actual outcome of the study was exactly the same, as depicted in the graphic below from the July 15 Market Measures:
As seen in the graphic, only 336 (35%) of occurrences were profitable, while 619 (65%) were not profitable.
The takeaway from this study is hence exactly the same as the broader examination, a strategy buying the earnings straddle in stocks over $100 five days before the event and held through the announcement lost money in 65% of trades. Meaning, the strategy wasn't profitable, on average.
Furthermore, the quoted Goldman Sachs study stated positive returns during 14 of the last 19 years. tastytrade found that the strategy lost in all but four years from 2002 to present. They additionally stated in Barron’s that buying straddles around earnings was profitable in five of the last 8 quarters. tastytrade found that strategy lost in seven of the last eight quarters.
We encourage you to review both of these compelling Market Measures episodes in greater detail when your schedule allows:
As always, please follow-up with any comments and questions below.
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