OAP 090: The Art & Options Strategy Behind Quick “Earnings Trades”

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We're now in the heart of earnings season for the current quarter and with hundreds of companies set to announce their performance we're presented as options traders with tons of opportunities to profit from the volatility crush that occurs after an announcement. But these fast (and often violent) moves in the underlying stock in the session following the announcement can often scare and confuse investors trading options.

In today's show, I want to walk through my strategy for filtering and finding good stocks to trades, strategies we like to use and how to set them up, as well as my thoughts on exiting trades shortly after the market open. If you've ever wanted to jump in and make some earnings trades, you'll want to tune in and take lots of notes. Don't forget, we've also got a free course and PDF guide to earnings trades available for members inside our education platform.

Key Points from Today's Show:

  • Every quarter, companies announce earnings, which results in an implied volatility crash.
  • Before the company announces earnings, there is a lot of pent-up hype about what might happen as they announce earnings.
  • As you approach earnings even, the implied volatility usually starts to increase; the expectation of a big move is always present before the event.
  • At the moment when the company announces their earnings, the market has to reprice the stock in real time.
  • There is a short duration and timeline of exposure which compresses the entire cycle of IV contraction down into a single moment.
  • The drawback of an earnings trade is that it exponentially increases the learning curve, with limited time to adjust.

Finding Earnings Trades

  • Focus on earnings trades that are coming up the week that you are trading.
  • Pair down your list to focus in on trading the big name securities.
  • Check to see the type of contracts that are available to trade, preferably short in duration and timeline.
  • Shorter contracts have most of the volatility priced into the security and it will react much faster to the earnings announcement.
  • The weekly contracts don't have much time value built in and so they will decay at a much faster rate.
  • Your IV rank has to be above 50 because you want to have a strong drop in IV, which only happens if IV is high to begin with.
  • Make sure there is good liquidity in the weekly options. Weekly contracts are generally less liquid than monthly contracts.
  • You want to see good volume and good open interest the week leading up to earnings varies depending on the security.
  • Make sure there is also good liquidity in the next monthly contract, in order to roll to the next month if adjustments need to be made.

The Expected Move.

  • You want to have a good understanding of how far does the market think that the stock is going to move.
  • The market will always expect that the stock moves more than it does long term.
  • However, most of the time the stock will move less than the market expected, long term.

Choosing A Strategy.

  • The first thing to look at is implied volatility:
  • If IV rank is in the upper end above 50%, always try to be more aggressive in your strategy selection, doing the straddle or selling the iron butterfly really wide.
  • If IV is 50%-75%, then you can be less aggressive doing more strangles and iron condors.

When to Get Into the Trade.

  • Too many traders get into the trade much too early.
  • Often times, leading up to an earnings announcement the stock may have a dramatic move the last day or so.
  • Need to be as neutral to the direction of the stock as humanly possible.
  • The best way to do stay neutral is to trade the options 30 to 45 minutes before the close of the day of or the day before they announce their earnings.

After the Trade.

  • Once the company announces earnings, the stock will naturally change in price.
  • This allows you to set up your strategy for exiting or adjusting.
  • If the stock moves within the expected range, shortly after the market opens you want to close your position.
  • If the stock moves more than expected, now you are faced with a situation where you need to adjust.
  • You first want to follow the same adjustment techniques we discussed.
  • You want to adjust by first rolling the tested side out to the next expiration month for a credit, if possible.
  • At the same time, roll out and roll in your untested side:
  • if the stock moves higher than expected, roll up your puts.
  • if the stock moves lower than expected, roll out your puts that are in the money and roll out and down your call side.
  • if the stock is aggressively going against you and is definitely well beyond your breakeven points, you want to start trying to make this adjustment now.

*Caveat: if you can make this adjustment for an overall credit, it is the best way.

  • Having the ability to add more timeline to your trade, more duration for the stock to come back around inside of its range is the best course of action.
  • if you cannot roll that trade out to the next month for a net credit, it's not worth doing.
  • Keep your position sizes small to avoid big potential losses.

Option Alpha Podcast Show Notes[FREE Download] Podcast Show Notes & Transcript PDF: No time to read the show notes right now? We've made it incredibly easy for you to save time by giving you instant access to the complete digital version of today's show. Click Here to Download Your FREE Copy

Free Options Trading Courses:

  • Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
  • Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
  • Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
  • Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
  • Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
  • Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
  • Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
  • Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A w/ Jerry

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. This week's question comes fromJerry who asks:

When using the watchlist during earnings season, if a stock is on the watchlist with a high implied volatility rank and has upcoming earnings, do you recommend considering it for both a normal trade like selling an iron condor 45 days out as well as a potential earnings trade? Or do you recommend only putting on the normal trades post earnings?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

  • The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
  • Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
  • Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
  • Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
  • When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
  • 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

  • EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
  • VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
  • DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
  • COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
  • TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
  • MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
  • IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
  • TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
  • XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
  • COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
  • EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
  • IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
  • SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

Thank You for Listening!

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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.