Option Long Straddle or Strangle For Baidu (BIDU) Earning Trade?

I have shared on how the option IV skew suggest price volatility for Baidu (BIDU) post earnings, I would like to share why I planned to trade the option by using the Long Strangle strategy in this article.

Baidu (BIDU) Option IV Skew Suggest Price Volatility Post Earnings

How Do We Choose Between Long Straddle or Strangle?

This very much depends on our objectives and risk tolerance. What I would generally think is long straddle will cost more, but the chance of us losing 100% will only occurs if Baidu stock price is exactly equal to the strike price at expiration.

Whereas, long strangle will be less expensive to buy, as its legs consist of out-of-the-money (OTM) options, but the long strangle has a higher chance of losing 100% when both options expire worthless if the underlying stock price is between the two strike prices at expiration.

Let us look at how Long Straddle and Strangle would look like for Baidu (BIDU)

Long Straddle

As Baidu last close price on last Friday (17 Nov) is at $108.10, we will use 108-strike options prices as shown in the table below, I would buy the straddle for $11.80 ($6.25 for the call and $5.55 for the put), we need to add transaction fees.

So if at expiration, if Baidu is at $108 + $11.80 ($118.80) or $108 - $11.80 ($96.20), then this straddle strategy would be profitable in theory.

But before that, as Baidu (BIDU) earnings release is tomorrow (21 Nov) before market open, we will be holding on to a long straddle or strangle through earnings. This can potentially be a double-edged sword.

While we might be looking to capitalize on a big move (price volatilty), but typically once the event has passed and the stock has its move one way or the other, IV and the option premiums tend to fall.

Normally, it would be better that before considering a long straddle or strangle ahead of an event (in this case, earnings, we can assess the impact of time decay and implied volatility.

For example, after an earnings report, it is pretty common to see IV (Implied Volatilty) to fall sharply. This is commonly known as the "volatility crush". I will share more later in another sections.

Long Strangle

For strangle, I could buy Put at strike price 106 and Call at strike price 110, this would cost $9.85 ($4.60 + $5.25), not including transaction fees. With this lower cost, there is a need for the stock to move more to make the strangle profitable.

At expiration, we would need Baidu to be below $96.15 ($106 - $9.85) or higher than $119.85 ($110 + $9.85). I have not taken volatility into consideration for this plan that I have just shared.

Baidu (BIDU) Post Earnings Implied Volatility

If we look at the implied volatility which is trending lower and also using the 252 HV as the long term benchmark, the implied volatility (44.3) is currently -6.9% below the 252 day HV (47.6) mean.

Why I would consider Long Strangle because I am expecting Baidu to have a price volatility, its peer, Alibaba has since suffered a drop in its share price, even though we might expect Baidu to do well, but their target market is in the same region, there should be some correlation.

Baidu (BIDU) IV Percentile Rank

BIDU implied volatility (IV) is 44.3, which is in the 40% percentile rank. This means that 40% of the time the IV was lower in the last year than the current level. The current IV (44.3) is -1.0% below its 20 day moving average (44.7) indicating implied volatility is trending lower.

Baidu (BIDU) IV vs 20-Day HV

The current IV (44.3) in BIDU is 23.7% above its 20 day HV (35.8) suggesting that options markets are predicting future volatility to trade above the most recent 20 day realized volatility.

Baidu (BIDU) IV vs 252-Day HV Divergence

Traders frequently use the difference between implied volatility and historical volatility to measure divergence from the mean.

Using the 252 HV as the long term benchmark, the implied volatility (44.3) is currently -6.9% below the 252 day HV (47.6) mean.

Summary

The IV percentile indicator compares the current IV to the 52-week high and low. The larger the IV percentile, the higher the current IV relative to values over the last year.

However, high IV does not necessarily mean the long straddle or strangle is too expensive to consider.

On the other hand, simply because IV is low relative to the past does not mean the long straddle or strangle is a bargain.

Because markets are forward-looking, implied volatility and option premiums are often changing based on expectations about the future volatility of the underlying stock.

I am choosing Long Strangle because I am expecting to see some share price volatiltiy trading once Baidu releases its result pre-market tomorrow.

Appreciate if you could share your thoughts in the comment section which option strategy would you go for? Long Straddle or Strangle? or other option strategy?

@TigerStars @Daily_Discussion @TigerWire appreciate if you could feature this article so that fellow tiger would benefit from my investing and trading thoughts.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.