Research In Motion Earnings Trade

Today after the close Research in Motion (RIMM), the maker of the Blackberry, announced earnings. It has a history of big moves after earnings. It is a very volatile stock. How can we play this?

Buy Straddles

The first idea is to buy an at the money straddle. RIMM closed today at 49.09, so we should look at the 50 straddle. The call sells for $3.30 and the put for $4.35. That means we would have to pay $7.65 for the straddle and the stock would have to go to 57.65 or drop to 52.35 for us to break even. That is a tall order. (By the way, RIMM is trading at 58 right now in after market trading.)

Why are the options so expensive? It is because the implied volatility is so high leading up to the earnings announcement. The uncertainty in what the earnings will be pumps up the implied volatility. The market remembers that Research in Motion makes large moves on earnings announcements and the options prices reflect that. The April 50 call has an implied volatility of 89% and the April 50 put has an implied volatility of 92%.

Sell Straddles

So maybe it is better to sell straddles and profit from the collapse in implied volatility. If we sold the straddle we would get $4.25 for the 50 put and $3.25 for the 50 call. We would earn $7.50 in premium so our breakeven points would be 57.50 and 42.50. As mentioned above, RIMM is trading at 58 after the market close, so that position would be a loser.

What we want to do is to profit from the coming collapse of implied volatility but not suffer if the stock moves too much. How can we accomplish that? If we sell the April options and buy May or June options we might be able to accomplish both goals. The May 50 puts have an implied volatility of 74% and the June puts have an implied volatility of 72%. This is near the top of its usual range. The bottom of the range is 50%. So we would expect the April volatility to drop to 70% or so and the May or June volatility to stay around 70%. It is possible that the May and June options implied volatility will drop to 60% and the April options will also.

Double Calendar Spread

So I sold the 35 April put and the 55 April call last week and bought the June 35 put and June 55 call in a spread. The way I thought of it was that the wider combination gave the stock room to roam, the near option volatility would collapse and the later month options would protect against large moves.

Let’s see how it plays out tomorrow.