Crazy, but towards the end of the day Friday Google’s April 500 strike call option was up 10,000% from the previous day’s price. That’s what I love about options, you can have incredible leverage in such a short amount of time.

I was wondering if I had held these options and had trouble selling them because it was the day before options expiration and was “stuck” holding onto these my understanding is that my broker would automatically exercise these options for me instead of letting the contracts go worthless. Great. However, if I didn’t have the capital in my account to purchase all of the stock that I had the right to, would that still happen then and they’d just immediately buy then sell them at market price come Monday morning? Or would they just let them expire since I didn’t have the capital to exercise them fully?  I believe the former action is what should take place (they’d exercise and then immediately sell them for me)

Earnings always have great potential to make some quick returns with options, either to sell the volatility preceding the announcements, pick a direction where you think it’s going, or create a straddle/strangle if you think it’s going to move big but not sure which way. Here are some stocks which I feel have a lot of up or downside potential in them during this earnings season.

RIMM’s up 15% after hours after posting earnings. This morning I bought some Jan 130 calls just because

1. I liked how the market responded to Oracle’s earnings yesterday and that instills confidence that the tech sector is still strong
2. The VIX is dropping which means a more saner market ahead of us
3. And, well, despite my better judgment, it just felt good, and I still love my Blackberry

I’m hoping I will have doubled my money by tomorrow morning. This is one of my favorite stocks to trade.

… The next day …

I sold out early this morning for a 54% gain when the stock was hovering around $117, but, hey, it was a one-day gain and in this wacky market I’ll take what I get. The stock’s at $119 now 2 hrs before market close which would have given me a 100% gain on the options but I’m OK with it. I think with volatility dropping though I would be more apt to hang on longer and not be so trigger happy.  In retrospect I should have just put a trailing stop on it to protect my profits while letting it run, but I’m not too familiar with that feature on optionsXpress yet but that’s something to study up on over the weekend.

On Wednseday morning Lehman Bros (LEH) released quarterly earnings. There was a lot of negative sentiment against LEH going into earnings and I considered getting buying some puts on Lehman but I didn’t do it soon enough and I don’t like buying options the day before the announcement due to the risk of getting caught in a volatility crush.

Shortly after the earnings announcement in the morning, the stock was down $2.08, almost a 3% move down. However, the December front-month ATM and OTM puts, which should have gone up, actually went down in price. The reason is that once the earnings came out uncertainty went down, which decreased volatility. Volatility affects options closer to expiration . This teaches 2 things when trying to time the market with options:

1. When volatility is high (like the market is now) beware of volatility crushes like these
2. You’re more likely to be a victim of volatility crushes when playing with options close to expiration

I had been the victim of a crush in the past and didn’t know what it was and didn’t understand why when the underlying stock of my calls went up why my call options went down in volume. That’s because as a beginner I often traded front-month option near earnings. Sometimes it worked as an earnings surprise was announced, surpassing all of the volatility premium I had paid for. However, on other times what the company announced was what everybody expected, or worse, and I got caught in a crush.

Biogen (BIIB) had been on a tear the last few months on speculation they were going to get bought out. I sensed that when they announced earnings earlier this week the stock might pop one way or another, but wasn’t sure which way. When we think a stock is going to move but we’re not sure which way then we can put on a straddle, or it’s more aggressive sibling, a strangle. I didn’t get around to putting on a trade since I have only recently learned this strategy and I was nervous trying to put on a trade so close to earnings.

Turns out the stock dropped hard after they announced on Thursday morning before the market’s open that they had not received any bids to be purchased. This caused all of the buyout speculation to wash away for a one-day $17 (approx 22%) drop.

Ok, since hindsight is 20/20 let’s look at how our supposed straddle or strangle migh have worked out for us.

On Wednesday, the day before the announcement, the stock closed at $75.05. A straddle, which buys calls and puts of the same strike price, usually ATM. So on Wednesday an April $75 straddle looked like this:

BIIB April $85 Straddle
Wednesday’s Closing prices
APR 75 Calls - $6.82 for a $682 debit
APR 75 Puts = $5.00 for a $500 debit
Total Debit = $1,182.00

Thursday Late Morning prices
Apr 75 Calls - $1.00 worth $100
Apr 75 Puts - $16.97worth $1,697.00
Total Straddle Value: $1,797.00
Total 1-day Gain: $615.00 or 52%

BIIB April $65/$85 Strangle
Wednesday’s Closing prices
APR 85 Calls - $2.40 for a $240 debit
APR 65 Puts = $1.90 for a $190 debit
Total Debit = $430.00

Thursday Late Morning prices
Apr 85 Calls - $0.30 worth $30.00
Apr 65 Puts - $10.01worth $1,010.00
Total Strangle Value: $1,040.00
Total 1-day Gain: $610.00 or 142%
So while the strangle made as much money as the straddle, the strangle made almost 3 times more money on a percentage basis because we would have risked much less money to get the same dollar return as the straddle.

P.S. I looked at April’s strikes to avoid a volatility crush so close to earnings and to buy some time in case our expected move doesn’t happen and we may want to modify or adjust our trade.