When To Exit An Earnings Trade (3 Case Studies)

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Earnings trade: In today's video tutorial, we're going through all of the trades that we made for Thursday, February 12. We had a pretty active day because we were closing out a bunch of our earnings, trades that we had from yesterday. We had four earnings trades to get out of today. More or less we ended up pretty much maybe about $50, $60 higher on the earnings trades.

We had one loser which is CSCO which is Cisco. Then the other ones were nice winners, but with the CSCO loser scratched out a lot of the winners that we could have had. Then we had two adjustment trades we'll go over and an opening trade in Groupon because Groupon is announcing earnings or announced earnings overnight already. 

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Let's first go over the Groupon earnings trade. Very, very similar to what we are typically doing with our earnings trades is trying to take in a credit and move outside of the expected range. Now Groupon is just a little bit different because it trades in such a narrow price range as far as strikes are concerned, and I'll show you this here in a second.

It trades in such a close range as far as strikes are concerned that we did an iron butterfly. In this case, we sold the seven and a half calls and the seven, and a half puts on either side. We did the same strike price on the calls and put to start on either end. That creates that iron butterfly. It looks like a butterfly spread, but it's two credit spreads on either side of the market.

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Then what we did is we went $1.50 outside on each end. You can see we moved $1.50 outside on each end. It makes it very balanced, very even, very symmetrical. We took a 91 cent credit which is just below what the expected move is. When we look at a chart here of Groupon you can see it out a nice little rally into earnings, but as you can see implied volatility is still very, very high in the 76 percentile.

We typically do see a nice little drop in implied volatility for stocks like Groupon and big name stocks. I anticipate seeing that quickly. As far as strikes are concerned, these are the strikes that we selected. Again, we focus all of our attention right over where the stock is trading right now which is about $7.50. What we decided to do is sell these strikes, and then we bought the wings on either end for protection.

Now you'll notice that the protection that we bought is only very cheap protection, so $7 and $9. That helps reduce our marginal requirement in the trade and also caps our loss in case Groupon does move substantially higher. When we look at the actual profit and loss diagram, again you can see it looks very similar to what a butterfly looks like, but our loss is capped at about $60 or so. We can't lose any more than that.

Risk, reward-wise, it's very, very favorable. If Groupon does stay inside the range it's currently trading in right now which is right around 10 or 12 cents above or below the market after it already announced earnings, then we stand to make at least our money back on risk as far as that's concerned. We could make at least $60 or more, and that's about the most that we're actually risking is about $60 on this trade.

Risk reward-wise, excellent trade, great liquidity in the options. You can see a couple of thousand shares sold or contracts traded on each end today, so very, very liquid as far as the underlined is concerned and as a result very tight markets which makes slippage pretty much a nonfactor in this case. Closing trades we got out of the first one which is Cisco, this one was the one that was a loser. It was a strangle.

Cisco made a move that was beyond its expected move, and we had the 27, and a half calls on the top side of our strangle. We just bought those calls back because the puts are so far below the market now. It doesn't make sense to buy those in this case. We did buy those back for 160 debits. That means we took a net loss of $60 on the Cisco trade.

If you look at Cisco again, the stock just made a huge move. There's nothing we can do to avoid that. That's just the nature of the beast, I guess. We did see a drop in implied volatility which helped, but at this point, it wasn't worth rolling to the next month because it was so far outside of where our strikes were. Our strikes on the top side at 27 and a half were about right there. The stock made almost two and a half times the expected move.

At that point, you just got to let it go. Keeping your trade size small was the best defense that we had because we only took a nice $60 loss. The other trades we had as far as earnings go, all were profitable. WFM, we had the 58.60 call spread, 48.46 put spread. Close that out for a six cent debit. We took a nice $33 profit there. This one looked like it was going to be a huge loser.

We thought the stock was going to open up well below $200. It opened up above $200 and sat there for a little while, so we were able to get out at a $105 debit and take a $20 profit, so nice little trade in that turned around. Tesla ended up being an enormous winner because the stock opened up well inside of its expected range. We had the 180, 185 put spread and him 235, 240 call spread. The stock opened up well above 180 in the 196 range. We were able to close that out very quickly at a $45 debit and bank about a $70 profit.

In all of these cases, we did see an enough good drop in implied volatility. Whole Foods saw that drop in implied volatility. The stock opened higher and then rallied much quicker, stronger towards the end of the day. It behooved you because the stock closed at 56.53. It behooved you if you were quick to get out of the trade because if it would have run any closer to 48 there, then this profit that we had or being able to close out at about 46 wouldn't have been there.

Again, implied volatility dropping that fast, even with the stock up 5%, you can't buy any of these strategies heading into earnings. You got to be a net option seller. Again like we said opened up above 200 which was great. Again, saw that drop in implied volatility which we needed to see. That helped to solidify the little profit that we had there in.. Then Tesla was a great one, saw a quick drop in implied volatility.

The stock opened around 196 and then rallied throughout the day. It ended up being, if you held onto it just a little bit longer, a colossal winner. Again, we just like to get out of these trades. We don't want to see them run up or run down. We don't want to get into a situation where we're playing it directional. We're trying just to focus and hone all of our attention on that drop in implied volatility.

If we can get that, that's what we're looking for. As far as trades that we adjusted, the first adjustment that we had was a vertical roll of our SPY credit call spread. We originally had the February 208, 209 credit call spread. We decided to roll that out to March. Now that SPY has taken off and rallied hard at the end of the day, we decided we wanted to turn this position out towards March. Still like it, still think that implied volatility is very high.

That's one of the key points here about rolling a strategy is that if implied volatility remains high, it's probably a good idea to roll. That's one of the key things. We want to see higher implied volatility on the roll. That helps us take in credit which we did. We took in $1 credit to roll, but also we want to still maintain the same directional assumption. At least for us, we're a little bit bearish on the market. We think maybe it's getting a little bit too high here. We could keep another bearish position in our portfolio for the next month.

Again, with this roll, all we're doing on a roll is closing out and buying back February and reestablishing the same position in March. Now the net difference between doing that was that $1 credit. We got paid $1 to roll this out. Actually, at the end of the day, this gives us a lot more time to see the market turnaround. We don't get all of that risk in holding the position the last week and a half here till expiration.

We also made an adjustment to our XLE Iron Condor. We added put spread to our XLE Iron Condor as the market has rallied higher, as oil has rallied higher. Most of our positions are doing well in oil. USO and RIG all doing well with oil rallying higher. XLE was one of the positions that we had which were playing oil to the bearish side. As a result of oil heading higher, we saw XLE start to go into the money on the call side.

We decided to add the side to our strategy. We added the 79.78 put spread for a 20 cent credit. This does two things for us. It widens out our break-even points by that credit. We get an extra 20 cents of room on our break even. It also recenters the strategy and reduces risk. Let's go through and look here and take a look at exactly what's happening. You can see that XLE has just been on a nice little run up as it's heading towards expiration.

Implied volatility stayed pretty constant here at the 60th percentile. Its high implied volatility makes this adjustment easy. Again, this is our resulting position in XLE, but let's break it down here. We got into the 79, 78 put spread. This was our original side of our Iron Condor, the 81, 82 call spread. You can see as the stock is moving higher, it just continues to threaten that side.

What we don't want is we don't want just to sit here and see this position welt away, and we have about $150 loss. At this point what we're doing is adding this adjustment to the chart here. You can see that now brings in the Iron Condor. It's much taller, much narrower inside of this range. It recenters the strategy over the market. Now we've got a little bit more simplicity on either side, so we don't have too much room on the call side.

We don't have too much room on the put side. We're more narrow; we want the stock to trade very flat over the next couple of days. If nothing else, it also reduces our risk. Notice that our maximum loss here has gone down to just a little over $100 from about $150. If nothing else happens, and if XLE continues to move higher, at least we've reduced our risk which is always the number one goal of making an adjustment.

As always, I hope you guys enjoyed these videos. If you have any comments or questions, please add them right below in the comment section. 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.