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Double Diagonals and IV effects

by Uncle Bob Williams

Double Diagonals and IV effects | example: AAPL Double Diagonal

The AAPL (Apple) Double Diagonal spreads had really nice profit/loss graphs, about a week before their earnings announcement.

The Apple Earnings announcement is 7 days in the future from the graph above.
Note: The underlying price can jump significantly at an earnings event - Apple's price jumped up $55 at their previous (April 2012) earnings announcement.
We recommend avoiding these types of strategies on individual stocks when there are earnings announcements, as you will see below.

We made a Paper Trade to show what would happen. As a Paper Trade, there was no risk, if the AAPL price jumped to far on their earnings announcement, we would remove the trade.

PAPER TRADE

SELL 1 Contract | AAPL | August 2012 Expiration | 645 | CALL
BUY 1 Contract | AAPL | September 2012 Expiration | 655 | CALL
- - -
SELL 1 Contract | AAPL | August 2012 Expiration | 570 | PUT
BUY 1 Contract | AAPL | September 2012 Expiration | 560 | PUT
Spread Price: $5.96 DEBIT

Maintenance Requirement: $2,200
Total Requirement: $2,796 ($2,200 maintenance + $596 Debit to enter the trade)
20 Day Yield: ~ 20%

Index at purchase: $606.05
Days until Expiration: 30


DAYS IN: 4 | A few days into the trade, it's the Weekend here.

The Apple Earnings announcement is on Tuesday after the Market closes.

Trade Status: Looking great so far! Let's see what happens after the earnings announcement.


DAYS IN: 6 | Earnings Day - before the earnings announcement

Our AAPL Double Diagonal is showing a 7.3% Profit.

As we got closer to the earnings announcement, the Volatilty on AAPL went up. Which means, the Options prices got more expensive as people anticipated a price jump at the earnings announcement.

Rising IV is good for Double Diagonals as the profit graph below shows.


DAYS IN: 7 | The Day AFTER the Earnings Annoucement - AAPL dropped over 4% on the open.

Our AAPL Double Diagonal survived the earnings announcement even though AAPL dropped over 4% on the open today, and our position is still showing a profit.

The position is still in the trading range, so we kept it open to watch what would happen when the IV would drop.

NOTE the RED lights on the IV Change in the Graph below.
If you look at the dark blue key indicators box in the image below, you will notice the 'RED lights' on the IV Change. Double Diagonals and Calendar spreads are very sensitive to IV changes, and when the IV goes DOWN, it is BAD. In this case, after the 'panic' of the earnings announcement was over, the IV values dropped back down to more 'normal' levels.

This trade is a little misleading because it is still showing a profit. Normally, an IV drop of that size would put a Double Diagonal or Calender spread into a loss. In this case, we entered this position early enough that we were able to profit from the rise in Volatility as the Market anticipated the earnings announcement - yesterday this position was showing a healthy profit after only a few days. Then the IV dropped back down, and we are fortunate enough to still show a profit based on the Theta (Time Value erosion) of our Short positions.


DAYS IN: 8 | The following day, the IV values continued to drop

Double Diagonals and Calendar spreads are very sensitive to IV changes, and when the IV goes DOWN, it is BAD. In this case, after the 'panic' of the earnings announcement was over, the IV values dropped significantly.

This is a great example to show how the drop in IV is dangerous to Double Diagonal spreads. Here we compare the Profit/Loss graph before and after the earnings announcement.

Notice how the drop in IV took a beautiful Double Diagonal spread with massive profit potential and turned it into a really bad trade. In most cases where the IV drops this much it, it would turn into a loss.

click on the image to enlarge

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