Lesson Overview

Earnings Adjustments

You've made a great earnings trade but what happens if the company gaps much higher or lower than the expected move that you planned for? When this eventually happens (and it well many times over the course of your career) you need to have a game plan in place to adjust the trade and reduce risk. In this video we walk through LIVE how it happened to us with a NFLX trade. This generally starts with rolling up the side of the trade that the market moved away from and taking in more of a credit to increase your break-even prices. I'll also discuss possible scenarios where rolling the trade to the next monthly contract is a viable strategy.

Show Video Transcript +

In this video tutorial, I want to talk about earnings trade adjustments. Unfortunately, we know that stocks will inevitably move outside of the expected range, and we have to be smart about how we adjust or hedge these positions post earnings, because not all the time is a stock going to move within the expected range, that’s only going to happen about 70% of the time.

How do we deal with stocks that make that move outside of that range about 30% of the time or less? The first thing we have to recognize is that when this happens, we are now playing defense, and the number one goal is to reduce risk first.

Sure, we want to leave room to make money, but that is secondary, no pun intended because of a football secondary, but that’s secondary to reducing risk first and foremost.

And that’s probably the number one thing that I see traders mess up with when it comes to adjusting trades, is that they adjust with the idea of making money first, and they should be adjusting with the concept of reducing risk wherever possible first and foremost.

Because now trades gone bad against you, you got to play defense; you've got to stop the homerun ball, you can’t let them score a touchdown, all those kind of things. You got to play defense first and reduce risk.

This comes in a two-step process, and we’ll go over this in much, much detail with an iron condor trade. A two-step process: The first step is that you roll the challenged side to the next monthly contract, keeping the strikes the same.

Now, it’s a little bit different, and I’ve got a different spin on this than most people do. But my thought process in rolling a contract from one month to the next month is one, to extend the timeline of the trade or the duration.

If for example, our calendar spread that we originally had, this dark line here on the chart, if our stock starts to challenge that calendar to the top side, meaning the stock makes a huge move higher, then what we want to do is we want to roll that trade from whatever month we’re into the next month, but we want to keep the strike prices the same.

And the reason that we do that is that we don't want to incur any additional risk by rolling that contract and increasing the strike price width or increasing the strike prices above the market.

I don't believe in doing that. I think that you got to keep that side the same because there’s a chance the stock might come back down. Now, the second step in this process is that you've got to move the unchallenged side closer to the new stock price and take in a bigger credit.

In our case with this iron condor, if the stock makes a huge move higher towards our call strikes, we’re going to move the put side in closer or roll the put side in closer because that side is already making money, we want to add that same type of strategy, just closer to the market and take in a bigger credit.

Now, what this does is that bigger credit helps widen the breakeven points on the trade overall which is a really good thing because now, that wider breakeven does move the breakeven of the call side up just a little bit higher.

That’s the exact process. We want to first roll the challenged side; then we want to roll up or move up the unchallenged side closer to the new stock price.

Now, in the following live example, we’ll walk through a trade right now on the screen in Netflix which Netflix made almost a two times expected move post earnings. It was supposed to move pretty much about $35.

It ended up moving about $50 to $60 after the earnings were announced, so a huge move that nobody could have seen coming, and we have to adjust it. But we wanted to walk through that live on the screen right after the market opened, and how we reduce risk by rolling the position to February from January.

Alright, here we are inside of my broker platform, and the market just opened, stocks are only open about a minute. And our Netflix trade that is the one that we’re really worried about here has already gone deep into the money. Netflix has made a huge move.

Let’s see if we can bring up Netflix’s chart here. It's made a huge move higher, and you can see well outside of the expected range, Netflix was only supposed to make a move to about 380 or so, so a very, very big move up in Netflix, and you can see implied volatility has already dropped.

But what we want to do is we want to roll up one side of our trade and then roll out the call side. I have not made these trades just yet. I'm going through this right now over this video with you guys live.

You can see we have this put spread and this call spread above the market. Our 390, 395 call spread is the one that’s currently on the money. And you can see Netflix is trading up here at about 410, and this call spread is deep on the money here.

What we’re going to do is we’re going to take this spread, and we’re going to roll it out to the February monthly contracts, try to take in some premium. We’re going to leave this put spread side alone because it's going to expire worthless today, but we’re going to add a new put side in February that’s going to be much closer to the current price of where Netflix is.

What we’re going to try to do is create a butterfly over the market. Let's go here, and we’re going to go here and try to roll this contract out. And you can see that we are going to…

In this case, because of where Netflix is trading right now, and I just want to make sure that a lot of these are showing up, that this Netflix trade right now, we can see (and let me just reduce this here) that our current call side is in the money, so the 390, 395 currently in the money.

What we’re going to do is we’re going to close this side of the trade, and we’re going to reopen it at the same strike prices out in February.

You can see the February options right now are trading about 30 days to go, and we want to enter that new trade in February, the 390, 395 as well. We want to do the same strike prices.

Now, we do this via a vertical roll. You can see this is the vertical roll order. We’re rolling one contract from one month to the next.

Now in this case, what we’re doing is closing out of the January weeklies, this is those JAN4 options, the 390, 395 call spread, and we’re entering a new trade with the same strike prices, 390, 395, the same number of contracts for February.

In this case, we’re going to take a small debit on this side of the trade. We’re going to pay money to roll because it's so deep in the money, but we should make up most of that cost and increase our trade by a net credit when we roll up the other side.

Here what we’re going to do is we’re going to just leave this order alone for a second, and what we’re going to do is replicate the order with a 390, 385 put spread below the market. You can see here, what we’re going to do is we’re going to add that 390, 385 put spread below the market.

That price right now is 155, so that more than covers the cost of rolling the call side, plus we've got a little bit of extra premium that we can take in from doing that. You can see the market is currently trading, so it’s about 145 or so to roll up that other side.

What we’re going to do is we’re going to go ahead and roll that side first. I’m going to make this order at the same time. Again, rolling up our put side to February, the 390, 385 puts for 145, and that might fill as we’re talking here.

And then what I want to do is I want to at the same time, roll out with this vertical roll our call side from January weeklies out to the February’s. Again, I’m just going to enter this order as well and roll these trades.

Now, both of these trades are now rolling and working, so we'll see if they get filled here. But that is the logistics of how we analyze and adjust a position that is moving against us.

And you can see that Netflix made a huge move against us, so our new position here will be reflective of our new risk in the stock as we head towards February. What I’m going to do is pause this video.

I’m going wait for these fills to happen, and then we’ll come back. Alright, we’re back now and you can see that those working orders that we had submitted quickly got filled in the market.

It’s just important to do this as soon as the market opens or as close to the market open as possible. And what we saw was a credit of 145 on the put spread that we sold, and then a debit of 165 on the roll of the call spread.

Now, this nets out to an extra $80 in premium which just helps reduce our risk in the trade. There’s nothing we can do in this trade except for reducing risk. That’s the number one thing that we have to do, is reduce risk, extend our trading duration, give ourselves an opportunity possibly to make some money back.

At this point, what the position looks like on the Analyze tab is it looks like a very tall slender butterfly. You can see we've rolled it all the way up to the 90 strike and the 85 strike on the put side, and we kept the same strikes, the 90 and 85 on the call side.

Again, the whole idea here is that it just gives us an opportunity to see Netflix possibly in the next 30 days move back down around 90.

And if it does, then in most cases, sometimes this will happen, it will trade back down around 90, that might give us an opportunity close this trade and bank a little bit more credit which helps reduce our loss.

But at this point, we have no additional loss if Netflix stays up here. We’re just continuing to add that credit. We can decide to continue to roll that put spread up if Netflix does move higher.

But at this point, we’ve reduced the loss as much as we can while still leaving an opportunity to make some money on this trade. That's why this Netflix adjustment is so important.

Again, you saw me go through it live right here on the trading platform. Now, the other thing is (real quick) we did have another earnings trade which is a full winner. Again, sometimes you have losing trades, and it's going to inevitably happen. You’ve got to deal with those positions first.

And then the other trade that we had today is an IBM iron condor. That trade we sold for $59 currently trading at $6. IBM moved well within the expected range, so that's a profitable trade that just helps offset some of the Netflix loss that we have on this particular day. Alright, hopefully, that was a really good example of how we are currently dealing with a trade that has gone against us.

And that’s one of the things that I think that makes Option Alpha so different, is that we’re able to show you live on our screen all of our trades, good or bad, and how we deal with them, and I think this is a key distinguishing factor between us and some of the other services that are out there in education platforms.

Again, with these adjustments and with the earnings trade adjustments, being smarter about your trades means having a system in place to deal with bad trades in a logical and systematic way. And I don't think that you have to subscribe to the system. You can do something else.

You can roll up the test aside if you want to, you could add some other type of strategy, but it really doesn't matter what you have, but you’ve got to think it out logically in advance, and make sure that you know in advance how you’re going to deal with a trade that goes wrong because that helps you from making emotional decisions that you whimsically make at the ebb and flow of the market.

Have a system in place, work that system, and do it consistently for every trade. And again, this is what I believe separates great traders from everyone else, and still, something that we’re continuing to perfect and evolve here at Option Alpha.

As always, I hope you guys enjoy these video tutorials. If you have any comments or questions about how we made this adjustment or any adjustments to earnings trades, please add them in the comment section right below this lesson page. And until next time, happy trading!

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