Weekly options can be used to create a surprising amount of cash flow if you employ the double diagonal strategy leading up to earnings. In this video we show you an example of using weekly options in CMG to create a potentially risk free trade as CMG heads into its quarterly earnings release.
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in this video we’re going to show you a
very interesting strategy for pulling
the risk out of a trade on stocks
leading up to earnings so that by the
time the earnings date arrives you’ll be
faced with an attractive situation that
you might have not thought possible
I’m the head options trader on our
trading desk here at SMB capital in
Manhattan and the traders on our desk
are constantly seeking to develop
trading ideas where risk is minimized
and reward is maximized so if you’re
interested in a way that you can set
yourself up with minimal risk on a trade
while putting yourself into a position
for really solid gains you should stick
around because I think you’re going to
find this intriguing
[Music]
hi I’m Seth Freiburg and I’m the head
trader of SMB capitals options trading
desk SMB capital is a proprietary
trading firm located in midtown
Manhattan and we provide capital for
options and equity traders from all over
the world trading both remotely and in
our offices here in New York City now
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okay so Chipotle Mexican Grill with the
ticker symbol CMG was trading around
8:35 and as you can see since late July
the stock price was channeling between
780 and 850 Chipotle was scheduled to
release its third quarter earnings
report on October 22nd and most stocks
will have an unusually large reaction to
their earnings reports as the earnings
report will often be a catalyst that
will cause the stock’s price to break
out of its range that it was in prior to
the earnings report being released now
before we delve into this option
strategy it’s important that everyone
have a basic understanding of how
options work most of you probably know
something about options but just four
really super quick review what’s known
as a call option on a stock entitles the
buyer of that option to purchase 100
shares of that stock at a certain price
called the strike price of that option
regardless of what price the stock is
trading what’s called a put option on
the other hand entitles the buyer of
that put to sell 100 shares of a stock
he owns at the strike price of that put
again regardless of what price the stock
is trading the buyer of the option pays
what’s called a premium to the seller of
the option because the seller of the
option is taking the risk that the stock
will go past the strike price of the
option in which case the buyer can
exercise his option but if the stock
when the expiration day of the option is
not beyond the strike price of the
option then the seller just pockets the
premium that he was given by the buyer
he walks away completely free of any
obligation so for example let’s say you
think that CMG will go up a lot after
earnings well in that case you might buy
the CMG 8:55 call that you can see here
which costs $27 and 51 cents but
each option represents the right to buy
100 shares of CMG and so you multiply
that by 100 to get the cost of that call
which is actually a cash outlay of two
thousand seven hundred fifty one dollars
twenty seven dollars and 51 cents times
100 or suppose you own CMG stock and you
think that it may go down after earnings
well in that case you might decide to
buy that 775 CMG put for $14 and 52
cents which again is multiplied by 100
because that represents the right to
sell 100 shares of CMG at any time
between now and October 25th so that
would put that put would cost 100 times
that or one thousand four hundred
fifty-two dollars now if CMG closes
above 775 then the put will actually
expire worthless because the right to
sell CMG shares at 775 when the stock is
trading above that is obviously a
worthless right the same thing goes for
the case for CMG closes below 855 on
expiration day October 25th in that case
the call option will expire worthless
because no one will exercise their right
to buy a stock at a higher price than
it’s trading so those are the basics of
how stock options work using CMG as an
example now with that in mind suppose
that on September 20th we go in and buy
both the 855 call and the 775 put on CMG
as you see well that combination buying
both a call and a put above and below
the market price respectively is what is
known as a strangle two options
professionals well the total cost of the
strangle as you can see from the
calculation is four thousand two hundred
and three dollars now here’s where it
gets interesting
remember CMG was channeling between 780
and 850 for the last six weeks so it
wouldn’t be unreasonable to expect that
there’s a decent chance that that
channeling would continue until the next
major catalyst which would probably be
CMG’s next earnings released so what
some options traders will do at this
point is to go about a week out and at
the same time they buy the long call in
the long put in other words at the same
time they buy the long strangle they’ll
go in and sell a short strangle
at 780 and 850 the outer range of the
channel on the upside and the downside
of the stock’s price now when you do
this selling a tighter to the market
strangle in the front week and buy a
farther from the market strangle in the
back month that entire combination is
what is known as a double diagonal so
that is how we enter the trade on
September 20th which is 33 days before
earnings are going to be released and 36
days before the long straddle expires
now let’s break down the economics of
what has happened as we entered the
double diagonal as we mentioned before
the long strangle expiring on October
25th cost us forty two hundred and three
dollars but we’re simultaneously selling
against that long strangle the 850 calls
for four hundred seventy one dollars and
the 780 put for eighty two dollars so
that nets down the cost of the original
strangle that we bought to expire after
earnings to three thousand six hundred
fifty dollars okay so that’s our first
trade in what’s going to be a campaign
as you’ll see shortly before we get into
how this trade actually would have
turned out I wanted to mention that
we’re currently running a to our free
intensive workshop at the moment where
we’ll be teaching you three real-world
option strategies that professional
options traders use including a really
simple but incredibly effective strategy
that some of the greatest investors in
the world like Warren Buffett used all
of the time plus an options trading
strategy that has a statistical 80
percent probability of profit month in
and month out plus an option strategy
that you can employ with the stock that
you like where you’ll make your target
profit whether the stock goes up goes
nowhere or believe it or not even if it
goes down a small percentage you’ll make
your target profits so if those
strategies would be of interest to you
then you should check out the free
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will open the free registration page in
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so don’t worry you won’t lose this video
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now on our CMG trade we move forward
about a week and as you can see the CMG
has sold off a bit down to 817 and the
options that we sold Leslie will be
expiring in about five hours so to close
those short options and end that part of
the trade we can buy those back very
cheaply because they’re so far from the
money with only five hours to go that
the whole market knows it’s very
unlikely the price will reach 850 in
five hours nor drop to 780 in a few
hours so as a result as you can see we
by the expiring 850 calls for just seven
cents and we buy the expiring 780 calls
for just 35 cents so the total cost to
buy those two short expiring options
back was a total of 42 dollars and then
at the same time we go ahead and sell
the same strike prices 850 on the calls
and 780 on the puts for the next weeks
expiration collecting one dollar and 48
cents and two dollars and 63 cents for
the calls and puts respectively now
let’s take a look at where we stand on
cash flow at this point okay well we
have our original long strangle cost of
40 203 and we subtract from that the
cash flow we get we got from the first
week short strangle at 8:50 and 780 and
you remember we brought in 553 for those
now to close those a week later we just
showed you that we’re paying only $42
but remember now we’re also selling
those same strikes into the next week so
we receive an additional 148 dollars for
the new short call and another 263 for
the new short put so the total cost of
the trade is now going down to three
thousand two hundred eighty one dollars
almost a thousand dollars below the
original cost now let’s move forward
another week now at this point the CMG
has been relatively stable trading up
slightly to a twenty but again the
options we sold the week before and now
going to expire in a few hours and so
they can be bought back really cheaply
because they just aren’t worth much
the chances of CMG getting to 850 or
7080 is remote again over the next five
hours so
we can again by those cheaply 12 cents
for the calls and 20 cents for the puts
to close those short options and at the
same time open up new short options
again at the same strikes as we did the
previous two weeks 850 and 780 selling
that calls for 228 this time and selling
the puts for 281 so as you can see from
the calculations if we look at the costs
now you’ll see that if you add in all
the credits we’ve gotten so far from the
short options and net that out of the
from the cost of buying back those short
options right before they expire you’ll
see that our cash flow is now down to an
outlay of a little over $2,800 so we
move yet another week where CMG has
moved up to 841 now and we do the same
thing rolling the short calls and puts
into the next week this time paying 64
cents to close the expiring options and
rolling them into the next week for
incoming cash flow of 862 cents so doing
the math now adding up all of the cash
we received for all the short options we
sold and netting those out with the
small amounts that we’ve had to pay to
buy those short positions back we’ve
gotten our cash outlay on the trade now
down to just a little bit over 2000
dollars now that’s half of our original
cash outlay okay so now this is where it
gets really really interesting so
finally we get to the week before the
long straddle that we bought a month ago
so the whole trade is really leading up
to what’s going to happen this week
because this week is also the week right
before earnings takes place in fact
earnings will be released in four days
while these options will actually expire
after earnings in seven days so the
implications of that are significant
because now we are for the first time in
this trade going to be selling options
that are going to expire after earnings
now what this means is that the options
market is going to really pump up the
price of those options because look CMG
is now trading at 8:45 and earnings are
about to be announced so that’s huge
because remember we are repeatedly
selling the 850 calls each week so now
those calls are only
five points from the price of the stock
with only four days to go before
earnings and even those 780 puts are
really pumped up in priced because even
though they are 65 points below the
money with a high-priced stock like CMG
a 65 point downward move is not possible
if CMG has a terrible earnings report so
we’re being paid hugely as you can see
for these short options you can see
we’re getting paid twenty seven dollars
and 88 cents for those calls and eight
dollars and 81 cents for those puts and
since each of those options represents
100 shares we’re getting paid a whopping
three thousand six hundred sixty nine
dollars for the shorts whereas in the
previous weeks with short options not
exposed to earnings we were getting
somewhere in the neighborhood of five
hundred to a thousand dollars for this
short call and the short put in the new
week now we’re getting three thousand
six hundred sixty nine dollars that’s a
massive increase and that’s because
earnings are coming very shortly so now
it’s important to understand exactly
what that means so if we look at the
cash flow coming into the final week of
the trade we find something amazing if
you add the cash inflow from selling
those final pumped-up options in the
week before expiration you’ll see
something amazing which is now just by
rolling those same strike call and put
options each week from one week to
another
we now have positive cash flow in the
trade and that positive flow is 1517
dollars we’ve basically paid ourselves
back for the total cost of the original
strangle that that expired after
expiration week plus we received an
additional $1,500 through this campaign
of selling the options against those
Long’s now let’s move forward to the
expiration day of the option in this of
the options in this trade all of which
now expire on October 25th so an
expiration day the CMG closed at 792 it
turns out the market did not like its
earnings report and so let’s see what
happens with each option well the long
call at 855 that we bought a month ago
and the short quality 50 that we sold
last week well those both expire
worthless
because the stock is trading 60 points
or so below those options so the right
to buy the CMG shares at 8:50 and 8:55
have no value and the 780 short puts we
sold last week and the 775 puts we
bought a month ago
well those expire worthless also because
they have no value CMG is trading at 792
so no one is gonna sell their shares for
780 or less when they’re trading at 792
obviously so all four options go out
worthless which means something great
and that is that the trade is over but
we still have our 1,500 dollars of cash
flow that we collected during the
trading by the campaign of rolling those
short options every week now I do want
to caution you for reasons that we can
go into in another video that had CMG
closed above 850 or below 780 that there
was a possibility that the trade could
have yielded as little as $1,000 in
profit but once we sold those final
short calls and puts an expiration week
there was no way that the trade could
have lost money it the minimum would
have made would have been $1,000 so what
I’d like you to take away from this
video is the fact that professional
options traders find all sorts of ways
to take advantage of the unique changes
in options pricing especially as they
approach earnings through understanding
options behavior you could unlock a lot
of potential profits in areas that you
might never have thought possible just
to remind you as I said earlier if you
enjoyed this video and learn something
valuable from it and would like to learn
the details of 3 real-world option
strategies that professional options
traders use all the time then you should
check out the free options class that
we’re currently running just go ahead
and click the link that should be
appearing now at the top right corner of
your screen
that will open the free registration
page in a new window so you won’t lose
this video don’t worry or you can just
go ahead and head on over to options
class com to register for this free
intensive workshop it’s really a rare
opportunity for retail traders and
investors to learn directly from Wall
Street traders but that’s exactly what
you’ll be getting through this free
online workshop so click the link to
sign up now and
don’t miss it and if you found this
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* no relevant positions
