Large trader straddling earnings?

02/03/22
  • Large trades in IRTC options suggest possible “straddle” position
  • Limited-risk strategy, but also potentially expensive
  • Strategy neutral on stock price, long volatility

A large trader (or at least a well-organized group of smaller traders) appeared to take an interest in medical tech stock iRhythm Technologies (IRTC) this week—in a way that highlights the potential risks and rewards of a well-known options strategy.

Traders watching IRTC on Monday would have found it difficult to miss the following trades hitting the tape, since they were just about the only activity in the stock’s March options:

Chart 1: Chart: iRhythm Technologies (IRTC) March options, 1/31/22. iRhythm Technologies (IRTC) options chain. 1,100-contract straddle?

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)


Since open interest (OI) was zero in the $115 calls and 1 in the $115 puts, we know the 1,100 contracts that traded in both options consisted of new positions rather than the liquidation of existing ones—i.e., someone was getting into the market, not out of it (see “Interesting options development”).

While this activity could represent a wide range of strategies, identical call and put positions will make many traders automatically think “straddle.” The combination of a long call and a long put with the same strike price and expiration creates a position that can profit if the market moves far enough—up or down—to compensate for the combined cost of the options:

Chart 2: Risk-reward profile: Long straddle. Long options straddle risk-reward profile. Limited risk, but potentially high barrier to profitability.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)


Setting aside for a moment that Monday’s trades could have been the result of someone initiating a short strangle—i.e., selling both options to collect premium and expecting the stock to trade in a confined range—let’s focus for a moment on the long side of the equation: What does a trader putting on a long straddle expect to happen? Two initial considerations:

1. While a long straddle’s risk is limited to the cost of the options, experienced traders know it’s also a low-probability trade, since that cost is often significant. No matter what the stock does, both options will lose some of their value every day because of time decay.

2. As the chart shows, the long straddle’s loss is greatest if the stock doesn’t move at all, in which case both options would expire worthless. That means the strategy benefits from more price movement than less—in other words, it’s a long-volatility strategy. The stock price can go up or down, but volatility definitely needs to go up.

Just as if you were buying a stock, if you’re “buying” volatility, you would naturally want to buy it low and sell it high. That means focusing on options with relatively low implied volatility (IV), with the expectation that IV will climb (say, if the stock makes a big move) and increase the value of your options.

The bottom of the following chart shows IRTC’s IV has recently been lower than its historical volatility (HV)—which means IV may be low relative to how much the stock has been moving:

Chart 3: iRhythm Technologies (IRTC), 10/27/21–2/2/22. iRhythm Technologies (IRTC) price chart. IV lower than HV.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)


The chart also shows IV has been trending lower over the past couple of months and is toward the lower end of its three-month range. (Similarly, IV for the March options was below its 30-day average yesterday.) So, from this perspective at least, a trader putting on a long straddle would have been “buying volatility” closer to its recent lows than its recent highs.

But here’s one detail some traders may not have noticed: IRTC is due to release earnings on February 24. Options IV sometimes climbs in the two to three weeks before earnings, as traders price in the possibility of a big stock reaction. In other words, there’s the potential for IV to rise (which could increase options prices) even if the stock doesn’t make an exceptionally large near-term move.

Would all those factors be enough to create favorable odds for a long straddle in this type of situation? It’s impossible to say—just as it’s impossible to say if Monday’s trades did, in fact, represent a large straddle position. And even if they did, since there’s a seller for every buyer, the traders who sold those options on Monday may turn out to be the ones on the right side of the market.

Either way, options traders always have to know which side of the volatility fence they’re operating on.

Market Mover Update: March WTI crude oil (CLH2) may have hit another contract high on Wednesday, but the bigger energy story recently has been the surge in natural gas prices: Yesterday March natural gas (NGH2) jumped more than 16% intraday to hit a three-month high and run its gain over the past nine trading days to more than 45%.

Today’s numbers include (all times ET): Challenger Job-Cut Report (7:30 a.m.), Weekly Jobless Claims (8:30 a.m.), Productivity and Costs (8:30 a.m.), PMI Composite Final (9:45 a.m.), Factory Orders (10 a.m.), ISM Services Index (10 a.m.), EIA Natural Gas Report (10:30 a.m.).

Today’s earnings include: Amazon.com (AMZN), Hershey (HSY), Penn National Gaming (PENN), Ralph Lauren (RL), Biogen (BIIB), ConocoPhillips (COP), Merck (MRK), Honeywell (HON), Eli Lilly (LLY), Snap (SNAP), Bill.com (BILL), Pinterest (PINS), Ford (F), Clorox (CLX).

 

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