Every quarter, Indian. companies announce their latest earnings and sales results. Sometimes, this information is entirely in line with expectations and the market basically shrugs its collective shoulders. At other times, however, a company unleashes an earnings surprise, and the stock market reacts in a decisive fashion. Sometimes, the reported results are much better than expected - a positive earnings surprise - and the stock reacts by advancing sharply in a very short period of time to bring the price of the stock back in line with its new and improved status. Likewise, if a company announces earnings and/or sales that are far worse than anticipated - a negative earnings surprise - this can result in a sharp, sudden decline in the price of the stock, as investors dump the shares in order to avoid holding onto a company now perceived to be "damaged goods"...............
Either scenario can offer a potentially profitable trading opportunity via the use of an option trading strategy known as the long straddle. Let's take a closer look at this strategy in action.
The Mechanics of the Long Straddle
A long straddle simply involves buying a call option and a put option with the same strike price and the same expiration month. In order to use a long straddle to play an earnings announcement, you must first determine when earnings will be announced for a given stock. You might also analyze the history of the stock itself to determine whether it is typically a volatile stock and if it has previously had large reactions to earnings announcements. The more volatile the stock and the more prone it is to react strongly to an earnings announcement, the better. Assuming you find a qualified stock, the next step is to determine when the next earnings announcement is due for that company and to establish a long straddle before earnings are announced.
You should take your position 3-5 days prior to results as option price increases prior to 1-2 days of such event.