How to Trade Stock Earnings with Options

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Stock earnings: In tonight's video we're going to go over the two earnings trades we have for Monday October 26th. This is going to be a pretty busy week for earnings, no doubt. We only got two orders filled. We tried to get into four different trades. We're kind of stretched on some of the other things as far as pricing, meaning that we wanted to get a little bit more credit than the market was giving at the time.

And because implied volatility wasn't as high as some of the ones like BABA and Coach which we got into here tonight. So we'll go over these two trades, but this is going to be a really busy week.

I know Wednesday and Thursday there's a ton of companies announcing earnings, and we're going to try to be a part of as many of these companies announcing earnings as possible that also meet our criteria. Meaning high implied volatility, pretty decent liquidity, and good pricing. 

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For earnings today in BABA, we went ahead and sold a wide strangle. Again, always using the weekly contracts ... The front-most contracts when they're available. They have all the volatility and premium juice built in, and they give us the best opportunity for the quickest decay in value after the earnings event.

Now with BABA, what we ended up doing is selling the 85 calls and the 69 puts down below the market. Each of those positions, or strikes, is set at about the one standard deviation level, about the 15% probability of being in the money on either side. It still was able to give us a nice credit of about $1.16 which is good.

It helps move our break-even point out just a little bit further. So here's a look at BABA again, implied volatility high in the 80th percentile. Stock's been on a bit of a run recently, but that doesn't mean that I can't change directions and go the other way for earnings.

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And again, with our strike prices we moved well outside the expected move. Inside of the Thinker's Sum platform, the expected move for BABA around earnings tomorrow is about $5.50. Our particular strikes move us past that move on either end. You can see our call strike up here at 85, that's about at the 15% probability of being in the money.

And then down below the market we went down to the 69 strikes, and you can see again that's about the 15% probability of being in the money. So we're trying to do this as balanced probability-wise as possible, and trying to do it late in the day.

And again, this is a great opportunity because the stock was up here today and over the last two days has been up from 70 to 76, so if you get into these earnings trades too early and you don't wait for that last day to enter the trade, you could be sitting with a position that's almost moved six plus dollars in the wrong direction, maybe, if you entered it two days ago.

So that's why we always want to enter these trades the day before earnings, right before the market closes. Just to get as neutral as we properly can. So, Taking a look at Coach ... Coach is the other one we got into. Obviously we want to do things super aggressive in Coach. With implied volatility at the 100th percentile ... Low stock price ...

It doesn't take a lot to carry the margin in a stock that's $30. And coach is right at about $30, give or take a few pennies on either side here. And so we wanted to do something super, super aggressive in Coach, and that's why we did the straddle right over the market at the 30 strikes.

Again, so we sold the 30 calls, sold the 30 puts, took in a nice big credit of $2.67. That does get us beyond the expected move. It's basically just at the expected move. The credit that we received ... Because the market's so fairly priced ... Gives us about a 70% chance of success right off the bat because it's equal to about a one standard deviation move in Coach tomorrow when it announces early.

So we'll see what happens, but we wanted to do things super, super aggressive and made it just ever so slightly directionally bearish just because of the stock having a real tough time this year. But you can see lots of liquidity in these strikes so it was very easy to get into and hopefully to get out of these things tomorrow.

So these are the two earnings trades. I don't know where the stocks are after-hours. Both of the companies announce before the bell tomorrow, but we'll obviously keep you guys updated as we go through the morning. 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.