Today, on this segment of "Market Measures", Tom Sosnoff and Tony Battista examine the idea of taking a shot by buying premium through cheap options.

Buying premium with the hopes of taking a large profit is alluring to new option traders. Traders may buy earnings premium, hoping for large moves outside the expected range, or they may look to buy cheap options with the hopes of hitting the jackpot. Our research team ran two studies to test this idea. One examined buying 0.10 to 0.20 calls every week. The second study tested buying 1.00 strangles before earnings.

Two stocks were chosen for the first test, NFLX and AAPL. They are both active and liquid stocks. the test period was from July 2010 to the present period. The study tested buying the closest OTM call for 0.10-0.20 in the weeklys and was held through expiration.

A chart is shown which displays the results of the P/L which deliniates when the strategy was above and below the zero line. A table is provided which shows the average debit, winning trades versus overall trades, the P/L, longest losing streak and biggest win.

The strategy buying 1.00 strangles before earnings was tested using AAPL, AMZN, BIDU, CRM, GS, IBM, LNKD, MA, NFLX, PCLN and V. There were 16 earnings cycles studied. Using weekly options a strangle was bought for an approximate 1.00 debit. The trade was held through expiration. A chart for this study was displayed showing the P/L results and the relation to the zero line. A table is displayed listing the number of winners and total trades, the P/L, longest losing streak (and total loss during streak) and biggest win.

Takeaways:

Each study provides solid facts of the wisdom of each strategy.

For other examples of why buying premium generally doesn’t work on a longer timespan, see “Premium: Why Selling It Works” on Oct 23, 2014. Additionally see “Premium: Far Out-Of-The-Money” on Oct 31, 2014.

Watch this episode of "Market Measures" with Tom Sosnoff and Tony Battista as they examine the strategy of taking a shot by buying cheap premium.