Option buy trade adjustment post event

An event is defined as anything that happens which is important. For traders, the event can be a wholesome event like the Union Budget or Election or a company-specific like Results, Mergers etc. Any one of these events can bring a lot of volatility.

More volatility means more potential to make money. This is why we all trade events. After 2 decades of existence, Options have made it easier for us to trade events. I do not think we need to touch upon how to trade direction during the event, but we do need to be careful of factors other than stock/index price while trading event with options. 2 key things happen once the even unfolds.

1. Possible volatility making unsustainable big moves in either direction

2. Sudden drop in Option Premium

My strategy for events has always been simple. Once the event unfolds just get out of the trade within minutes and not seconds. I highly recommend following the same strategy and get out of any option position created before the event. Initiate the new trade only once clarity emerges. I am not saying undue volatility cannot give the favorable move. However, that is more of a luck making money and not analysis.

Having said all that, there are situations when we are stuck in the middle of the post event excitements. What I mean is for Option Bought, we are favorable yet not completely satisfied with the post event outcome. This will prevent us from exiting the position. On the other hand, it is not advisable to hold on to the same position due to the 2 key things mentioned before. Here, we will use adjustments. This is for option buyers.

Let us say we bought a call option. Event result was positive for the stock, and it started moving up but not enough to book profit.

You still want to hold on to the position yet do not want 2 key problems to put pressure on your profits.

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Solution: Convert the bought trade into Modified Butterfly in two steps.

We know that the options are going to lose premium. As the first step we sell 2 Options against the 1 bought of a farther strike. A level where one would not mind booking profit.

Now the premium drop problem is solved but with 2 option sells, if the stock skyrockets, we will lose. So, to contain the loss just one step above the sold strike price Buy 1 lot of Call.

This will help in 2 ways. First, we will have contained loss. Second, because the number of options bought and sold are the same, spread margin required will go down significantly.

This trade is favourable for one more reason. We are selling options after making money in the Option Buy trade done before the event.

Following picture shows how the profits look like.

As we can see, just if the stock overshoots the farther bought strike, we will still make good money.

Lastly, this can be done with Puts also. Just Sell lower strike Puts and Buy just one step further lower Put.