If you are an options trader, then you know that earnings season is a time when volatility and volume spike. This can be a great opportunity to make some money if you are prepared! In this comprehensive guide, we will teach you everything you need to know about trading earnings with options. We will discuss:
- Why should we trade earnings?
- How do we pick the right stocks to trade for earnings?
- Which strategies are best for trading earnings utilizing options?
- Which strikes and expiration do we pick when trading earnings?
- How do we place an earnings trade?
- How do we manage earnings trades?
- When do we close earnings trades?
- What is the secret to why earnings trades can be so profitable?
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Why should we consider trading earnings?
The simple answer is that there is potential for a lot of profit! When a company releases its earnings, the stock price can move sharply in either direction. If you can correctly predict which way the stock will move, then you can make a tidy profit.
Even if we don’t think the stock will move much after earnings, we can trade both sides to profit. By selling both calls and puts we can collect a credit. The credit collected can be higher than normal due to the high IVR before the earnings release. Selling both sides can be done with a strangle. If done correctly, the strangle can be profitable when the stock price doesn’t move much.
Lastly, if the trade is not an immediate winner, we can just roll to the next month. It’s easy to do and we can often break even or turn it into a winner in just the next month. We will cover this when we get to the management of the earnings trade.
How do we pick the right stocks to trade for earnings?
The first thing you need to do before trading earnings is to find a stock that is scheduled to report. You can find this information on financial websites like Yahoo Finance or Google Finance.
Once you have found a stock that is scheduled to report, the next step is to evaluate the company and whether or not it meets the criteria for a good earnings trade.
Is the IVR high enough for an earnings trade?
We want to only trade stocks with high Implied Volatility Ratings. We need to receive enough premium to justify the risk. When IVR is high we can choose to widen the strikes or keep them closer to collect more premium.
Is the stock liquid enough to place an earnings trade?
The bid-ask spread will be wide on low-liquidity stocks. This will eat into our profits. We should only trade stocks with a tight bid-ask spread. These stocks will typically have a daily option trade volume of over 1M shares.
Does the underlying offer enough premium?
We always want to way the risk versus reward when trading options. We should only place trades with a good risk-reward setup. This means that the potential profit should be at least a dollar or more.
Which strategies are best for trading earnings utilizing options?
IV implied volatility is elevated before earnings announcements. For this reason, we want to sell premium (versus buying options). By selling options, we take on the role of the market maker. This allows us to define our risk while allowing us to profit if the stock doesn’t move as much as expected.
Two of the best strategies for trading earnings are Strangles and Iron Condors. We like these strategies because they allow us to sell premium, while still giving us the potential to profit if there is a fairly large move in either direction. The actual odds of the stock moving up or down following an earnings announcement is 50%.
For the lower-priced stocks, I like to trade Strangles. I will sell an out-of-the-money put and call. My goal is to have the stock stay inside of my strike prices so I can keep the entire premium as profit.
On the other hand, for stocks that are a little higher priced, I prefer to trade Iron Condors. This limits the buying power required. With this strategy, we sell both an out-of-the-money put and call, while also buying an even further out-of-the-money put and call. By doing this, we are still able to collect premium, but also are protected if there is a large move in either direction.
Which strikes and expiration do we pick when trading earnings?
We should pick the strike prices that are near the expected move. By doing this we increase our probability of success. By placing our strikes just inside the 1 standard deviation expected move we will be successful about 68% of the time.
We want to pick expiration dates that are close to the earnings announcement date. This allows us to capture the most amount of premium. I normally like to trade the nearest term regular options expirations which occur on the 3rd Friday of every month.
I will also take a look at the nearest weekly and decide between the two. I make my decision based on how much premium can be collected and how wide the strikes can be. Sometimes the IVR is much higher in the near term weekly which allows you to get quite a bit of premium in the shorter period.
How do we place an earnings trade?
Let’s look at an earnings trade example. Kroger is a liquid underlying with almost 2M shares traded. The stock has been trading in a range which makes it a great candidate for a Strangle or Iron Condor. It has a high IVR of 55 and earnings are tomorrow morning before the market opens. So we need to place the trade today.
We will sell the 47.5 Put and 50 Call with just 8 DTE days to expiration and collect 2.35 in option premium.
We hit review and send and we have placed an earnings trade in Kroger.
How do we manage earnings trades?
Management of earnings trades is relatively straightforward. If the stock price stays within our Put and Call strike range and we are profitable, we should close the trade at the open for the win.
For the Kroger trade placed above, it turned out to be a winner. So we closed it when the market opened by paying a .32 debit. Since we collected 2.35 when we placed the trade, it was a $203 winner in 1 day!
If the trade is a loser we can close the trade and take the loss. However, since we chose to sell the near-term expiration, we have some options. We can also choose to roll up or down the losing side of the trade to collect additional premium. We then hope that the price comes back to our profit range.
I also like to roll the trade to the next month. By doing this we can collect an additional premium. Often the move following earnings may be exaggerated since it moved outside of the expected range. I read the earnings report and conference call summary to see why it moved so much and outside of the expected move. If it is for a reason that shouldn’t be factored in so much, then I may leave the strikes the same or adjust and recenter them.
When do we close earnings trades?
The best scenario is to close earnings trades for wins right after earnings are announced. This will not always be the case though. Losers are managed as stated previously. Ultimately, after we roll or if we manage the trade, we should look to close when we reach 50% of the maximum profit.
What is the secret to why earnings trades can be so profitable?
Earnings trades can be profitable for a couple of reasons. First, there is around a 50% chance that the trade will be profitable immediately after the earnings release. In this case, you close for the win.
If the trade moves in either direction it will likely be near the expected move which is where you should have chosen your strikes. In this case, the trade will likely be a breakeven since one side will be a winner. Even if it is a slight loser, you can roll the complete trade to the following month and collect more premium.
IV will still be high if you do this right at the opening. Because of the big move after earnings, the stock may well stay in the trading range for the following month. So either way, you can likely profit and win.
In Conclusion
Trading earnings with options is a great way to collect premiums quickly. By using Strangles and Iron Condors, we can trade stocks and make money when they stay within a range. By choosing the right strikes, expiration date, and managing correctly we can be successful in trading earnings.
The key is to be patient and make the earnings trades that meet the criteria. By being disciplined and sticking to your trading plan, you can greatly improve your chances and make a lot of money.
Do you have any questions about trading earnings with options? Let me know in the comments below.
Also, if you are interested in learning about the coaching program, please shoot me an email at darren@darrensteves.com and we can book a 15-minute video call. We can talk about your goals and if you may be a good fit for the options coaching program. I’ve put a link down below that tells you more about the program.
Alright, guys, make it a great day, and happy trading!