I don’t normally follow TastyTrade. Not because they are not good content, but just I don’t have the time. But several times this SunnySide Up strategy crossed my desk.
I initially watched the video describing the trade. I was interested. It described an earnings trade that had good results however the upside included a naked short call. I paper traded some trades and saw massive blowouts (GMCR). I thought this is way too risky for me. It then crossed my desk again months later, I thought I would follow a few more paper trades and I saw a pretty big loss again (SPLK this time). But clearly my sample size was small and maybe I was choosing them incorrectly. One thing that really bothers me about the video is it lacks details. They give you parameters and some statistics, but don’t show you P/L curves or drawdowns. Considering there are naked short positions, I find this dubious. Lets test it.
This trade involves buying an ATM bull call spread and selling a naked call that is 84% OTM on the closest expiration. The naked call needs to bring in sufficient credit to pay for the spread. The trade is placed right before the earnings announcement, and the trade is closed the following day.
Example using LULU to show the structure.
As they describe in the video, earnings can go one of three ways: up, down or nowhere. This trade allows you to place a bet on two of those, capturing the volatility crush, but leaves you heavily exposed on the third. The majority of earnings are said to lie within the market makers expectations. Placing the naked call 84% OTM places it well outside 1 SD of the expected move. I don’t particularly like unhedged positions on binary events like these, but this is a nice setup.
Tasty trade shows the following results for testing 3 years worth of trades.
These look like nice results, but note that they don’t talk about those two loosing trades, nor did I catch how they allocate the trades. Is it 1 contract per trade or up to $X of margin per trade. I’ll assume they want to risk roughly the same amount per trade. Since they mention very expensive stocks, and the margin on these is very high, I’ll assume to an initial max margin of $20k per trade.
I’ll try to stick to the same parameters as TT. They mention this only works on expensive stocks, but I didn’t catch the threshold price, so I will start with a minimum underlying of $100. I am also going to use the delta on the short-call as a proxy for the ITM%. Not perfect, but the closer to expiration, the closer these numbers converge.
This is the profit and loss curve for the last 3 years ending 7/30 (at the moment I have data up to this date).
These are not cherry-picked results. This is simply the last 3 years of data from the last data point I have. That’s a pretty steep drop due to ISRG’s earnings. I double checked the results in TOS’s thinkback:
Sure enough TOS confirms my results. Also, TOS shows an IV rank of around 85% for ISRG on that day. I think by all accounts, this is a trade that falls well within their parameters. But it blew away 3 years worth of gains overnight.
If I change the underlying price threshold to $50, I get the following results:
A much more rocky ride, but at least profitable.
Out of curiosity, I also looked at this trade over the last 5 years. Curiously,these trade setups were very hard to find prior to 3 years ago. There just wasn’t enough vol bid into the short calls from what I can see.
I freely admit that I am fairly conservative when it comes to trading. I like earnings events, but this trade makes me nervous. First, the returns are not that great. I like a 2% return overnight, but the trade setup is hard to find.
Second, there are a few very large losses (ISRG, GOOG, GMCR, CMG, NFLX) that can overwhelm any profit you might have. When 3+ years of profits can be annihilated with 1 bad trade, well that’s just a trade setup I don’t really like. Sure bad trades can happen in other setups and have similar consequences, but this is overnight. There is no possibility to manage this trade within market hours.