How To Enter Earnings Options Trades With Strangles

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Earnings trade: In tonight's video update, I want to go over all of the opening trades that we had for today, Wednesday, April 11th. Today, we got into a couple of trades, a new opening earnings trade in BBBY and then also two additional trades in IYR and FXI which is another iron condor. I want to go over the earnings trade in BBBY first because I think it’s a pretty impressive trade and one that we had pre-talked about with some of our premium members on the weekly strategy call that we had earlier this week.

This is one that was definitely on our radar; there was virtually no doubt that we’re going to get into this, and I like the pricing that we got on this trade as well, and I’ll show you how I got there. With this trade, we traded the weekly options, and they were the April 2s. And you’ll notice that every time that we do a weekly option, the weekly options tag or code is right next to it.

And the April 2 means that it’s the April contracts, the second weekly contract, so the 2nd Friday contract. There’s a video tutorial inside of the membership area. If you are unfamiliar with how these weekly tags work, it goes over everything step-by-step. But this April 2s means the 2nd Friday of April is when they expire, so that would be this week on the 10th.

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For this strangle in BBBY, we did the 81 calls and the 72 puts for a total credit of 112, so a nice premium that we took in. That $112 moves our breakeven point out another dollar plus on either end. When we look at the chart here of Bed Bath & Beyond, you can see the stock has been a long time earnings crush reliable security.

Every time that the stock has earnings, we see that huge drop in implied volatility, and it’s usually preceded by a pretty big move up in implied volatility as well. And what we’re expecting here is that we’re going to see about the same thing and I'm sure we will tomorrow. As soon as the stock opened, it already announced earnings after hours and has already made a little bit of a move, but the stock ended today about $77.

Now, when we get into the trade tab, what’s important here is that you have to look at the measured or expected move. Inside Thinkorswim, they have this little area called MMM. And today, the measured or planned move that the market was expecting was around 370. It’s gone down just a little bit right before the close to about 339, but it was a little bit higher than that at about 370. What this was saying was that the market was expecting after earnings for BBBY to make a move of about $4 in either direction.

I’m just rounding up here, just giving ourselves a little bit of cushion on either end. Now, of course, we’re always going to trade the front most weekly contracts, and these are the April weeklies, only two days left. These have all the volatility and time decay juice that’s in them. And since the stock closed at about 77.5, we wanted to go outside of that expected range which was about $4.

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We ended up going a little bit further than that on each end because the markets were liquid, very wide, excellent liquidity, you can see there are some contracts that were traded all in that same region. On the put side, we went down to 72 which was more than $5 below the market, so well outside of the expected range.

And on the call side, we went up to 81, again, well outside of that expected range, lots of volume and liquidity for the 81s which made it easy to get into and obviously should be pretty easy to get out of. Now, the stock is trading after hours at just about 75 or so. It’s already made its move; it’s already announced earnings and it’s moved inside of our expected range.

Unless anything crazy happens between today or tonight and tomorrow morning when the stock opened, then this will give us an opportunity to close this thing are at a pretty healthy profit for a one-day trade. An excellent trade in BBBY. We could’ve obviously made an iron condor out of this if you didn't trade the strangle. In which case, you would’ve wanted to buy the 71.5 or 71 puts.

You’re going to spend a little bit of money to buy protection on either end. On the call side, you could’ve bought the 81.5 or the 82 puts, and you would’ve taken in less credit than we took in at 112, but you definitely could've still made some money on this trade and did the iron condor instead.

The next trade that we got into today is IRY. It is an ETF that tracks real estate, interesting because it has high implied volatility right now and relatively good liquidity. Now, we did trade two of the vertical May 82/84 call spread, so we sold the 82s, bought the 84s, took in a $.33 credit. Pricing and liquidity were pretty good for IRY, and we’ll just take a look here at the chart, and you can see we're just playing this directionally bearish just because of what we've seen over the last month or so.

Just the fact that the stock has topped out, it's made some attempts to rally higher and just keeps getting pushed down every single time that it does, so we’re just playing it a little bit directionally down. But implied volatility is still over that 50th percentile, so it's a good time to sell implied volatility. The one thing that I did wants just to bring to your attention when we look at the actual trade grid and the trade pricing for this thing…

And let me just go to the May contracts. The reason that we did the 82s and 84s was that the 84s and 82s had most of the volume and open interest for that particular day or today, so for this given day. We could’ve done the 83s, but you see that the 83s just had a little bit less volume and liquidity. And for our case, we just wanted to… We had a little bit more capital to use so that we could use a little bit more money in this trade, but we also wanted to go where volume and liquidity was.

And you can see that both the 82s and the 84s had just a little bit more active pools of traders and that just was maybe a little factor in doing this. Not to say it’s always the factor in doing this, but for our pricing that we wanted to see and just how much we wanted to get into, it just made sense to go to where the liquidity was. That’s our trade. We’ll leave that one on and try to let it ride out most of the expiration cycle.

Now, we also got into a very massive and high credit FXI iron butterfly. And the reason that we did this was that FXI made a huge move higher today and probably a trade that caught most people off guard because it made such a big gap higher. In fact, I know a lot of traders that I’ve seen online were closing out positions and closing out their short positions in FXI because it made a huge move higher.

Now, we traded the iron butterfly, so we did the 49/54 call spread and the 49/44 put spread. You’ll notice that each of these strikes is $5 wide, so we did a $5 wide spread on each side of the market, but our short strikes were the same at 49. You can think of it as an enormous butterfly, or you can think of it as a straddle right over the market at 49 with buying the wings on either end or buying protection.

We took in a pretty nice credit of about 290. That gives us a very wide range to make some money, and hopefully, we see implied volatility start to head lower relatively soon in FXI. But here's the chart here and you can see obviously the huge, huge move that FXI had. Now, we still have the put spread below the market at 42.40. That thing is profitable, but you'll notice as the stock has rallied, implied volatility has gone up through the roof.

And this is an excellent case study to point to the fact that every time that stock rallies, it doesn't necessarily mean that implied volatility is going to drop as far and as fast that this thing has moved. You’ll notice that implied volatility is now in the 94th percentile, so it’s extremely high right now which means that option selling is exactly what we need to be doing.

Now, we could’ve done a straddle on this, but given the fact that it’s gapped so much, I don't know what’s going to happen tomorrow. It could gap much higher. It could gap much lower. It could stay flat. I didn’t want to do a straddle with undefined risk on each side, so we did decide to go with the iron butterfly. And that gives us those two positions that are directly right over the market.

You can see our two positions that are short are the 49 calls and the 49 puts right over the market or as close to wherever the market is as possible. And then we went out about $5 on either end and bought protection on either end, so this gives us a risk defined trade. And here's what that profit and loss diagram looks like for FXI. Let me just get off the other portion of it here.

You can see very, very neutral, very broad iron condor butterfly looking profit and loss diagram. And ideally, what we’re looking for here is just a very quick drop in implied volatility, maybe the stock settling down over the next two weeks or so and that should give us an opportunity to take a pretty quick profit. Now, we’re not going to hold onto this thing all the way to the end hoping to make $290. We’ll probably look to take this thing off at about $75 to $100 or so as far as a potential profit.

Risk wise, we don't want to hold this thing all the way through the expiration cycle. As always, I hope you guys enjoy these videos. If you have any comments or questions, please add them right below. If you're watching this video somewhere else out there online or on YouTube, you just have to understand that you're getting this video about 15 to 20 days after it's sent out to our members, so if you want real-time alerts and this video that goes along with all of our daily trading alerts, you’ve got to sign up for a membership at optionalpha.com. Until next time, happy trading!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.