Proven Ways To Profit From A Stock’s Earnings Release Using These 3 Option Strategies

earnings release
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Earnings are coming, and you want to trade - I get it.

Not only can earnings release season be an exciting and profitable time, it can be a very volatile time as well.

Maybe the company announced tremendous profits or disclosed more layoffs; either announcement could dramatically impact price movement. Typically, stocks surge higher or plunge lower depending on the information within the earning release.

Depending on how much you understand about how to properly leverage options, you can do very well or very badly. Unfortunately, many investors use the wrong approach when it comes to options and are left wondering what just happened.

With the right options strategy, however, earnings release season can be very profitable for well-educated options investors.

Keep reading to become one of those well-educated investors who can profit during earnings season. In this post, we will provide insight into:

  • what happens to the options market when companies report earnings
  • how to profitably leverage options after an earnings release
  • options strategies to avoid

How to Use Options After a Company Releases Earnings

So how do you trade options after a company releases earnings? And more importantly, how do you do it profitably?

When a company releases its earnings, investors gain insight about recent financial performance and future performance. However, there is some uncertainty during that time as well. Investors use the earnings release as an indicator for how the company will perform in the upcoming quarter.

When next quarter’s earnings are released, investors will gauge that performance against the expectations that had been set three months ago. Even when a company generates positive number, its stock can still take a significant hit if the company doesn’t exceed expectations by beating the estimates.

Implied Volatility

The market is said to be volatile during earnings season because the market takes last quarter’s earnings predictions into account and assumes the company will meet those predictions. That assumption is factored into the market’s calculation of the stock price.

When the quarter plays out and the company announces whether they actually missed or beat the earnings predictions from last quarter, uncertainty and volatility exist because, upon learning whether predictions were met or not, investors must process that new information in a short period of time. How the investors react in that short period of time will trigger upward or downward movement in the stock price.

The investors’ expectations drive what is called implied volatility in the options market.

Implied volatility (IV) is driven by the degree of fluctuation in stock price expected by the investors. So, the higher the expected movement, the higher the IV.

In general, a stock's IV will rise as it heads into earnings. Not because the stock is necessarily more or less volatile, but because there is a lot of uncertainty and or risk around what will happen during the earnings announcement.

When volatility increases, the premium on the option also increases and everything becomes more expensive.

This one-time event swells option premiums on BOTH sides of the market. For an options trader, this creates an opportunity to sell relatively expensive options and profit from their decline in value.

Volatility Crush

Conversely, when earnings are released, the market has a relatively better understanding of the company’s future so uncertainty typically dissipates. The volatility naturally decreases with the uncertainty; this decrease is called volatility crush (highlighted on the charts with the green line at the bottom) and lowers the price of the option.

Volatility Crush

Now of course we don’t always see a volatility drop, but in most cases we’ve researched IV has dropped very quickly after the earnings event.

Start The FREE Course on “Earnings Trades” Today: When companies announce earnings each quarter we get a one-time volatility crush. And while most traders try to profit from a big move in either direction, you'll learn why selling options short-term is the best way to go. Click here to view all 10 lessons ?

Target Options Selling Strategies

Knowing this fact, we need to focus purely on option strategies in which we are net sellers of options.

Within our membership program, we focus on three primary strategies around earnings:

  • Short straddles
  • Short strangles
  • Iron Condors

Most people who trade options grasp the concept of volatility crush and make trades that take advantage of the volatility. The three strategies above count on two things:

  • volatility occurring;
  • and the stock becoming stuck within a certain range.

When volatility is high, that range can be assumed to be higher than it normally is.

Short Straddle

A short straddle strategy is when an investor sells a call option and a put option of the same underlying stock with the same strike price and expiration date. The investor does this when he or she believes that the stock price will not move significantly during the life of the option contracts.

With short straddles, investors profit from the lack of movement in the stock price. This takes the guesswork out of options trading where investors place directional bets and the hope for a big move in stock price either higher or lower.

Short Strangle

A short strangle strategy is when an investor sells a put and a call of the same underlying stock with the same expiration date, when both of which are slightly OTM.

With short strangles, investors are limited in terms of profit, while risk is unlimited. Investors are willing to accept this risk if the underlying stock is expected to incur very little volatility in the short term.

Short strangles are essentially credit spreads, as a net credit is taken upon making the trade. Profits with a short strangle are maximized when, at the expiration date, the underlying stock price is in between the strike prices of the options being sold. When the options expire, they are worthless and your profit equals the entire amount of the initial credit.

When an investor enters a short strangle or straddle, they sell an OTM put and an OTM call at an equal distance from the current market price. By taking a neutral outlook on the possible move in the stock, we minimize our directional guess of an earnings pop or drop.

Selling a short put and call credit spread on each side does reduce your risk that a huge move will create a big loss for your portfolio. However, the cost of buying the additional options to protect your position means less potential profit.

It’s important to note that a big bet in one direction during earning season is not the way to go. Instead, if you stay non-directional, you can always adjust later as necessary. Regardless, as long as you stick to selling options with high implied volatility you should be much better off than buying options around earnings.

If you can’t sell options naked or don’t want to take on the additional margin risk, then you can use our third favorite strategy - the short iron condor.

Short Iron Condor

A short iron condor involves selling a put, buying a put, selling a call and buying a call.

The investor sells the put and buys another with a lower strike price and sells the call and buys another with a higher strike price. All options have the same expiration date.

Sounds confusing, I know. But you will get the hang of it with a little more information and some practice.

Iron condors result in a credit instead of a debit, so it pays money up front and creates a range of safety or a virtual safety net. In other words, if the stock price is within that range by expiration, you win.

Exit Or Roll Positions After Earnings?

Alright, so we’ve covered why to trade around earnings and a few strategies to use. Now, let’s briefly talk about managing the position after the stock re-opens post-earnings.

In nearly all cases, you’ll see some gap in the stock price as investors react to the company news.

If the stock stays within the strike prices of your position, you can easily exit the trade and close out the position for a profit. This is the ideal outcome, of course.

But we all know that the market doesn’t always do what we want, right?

So, what do you do if the stock moves outside your strikes and goes ITM? We do have some options (no pun intended).

Rolling an option, as you may already know, is a way to manage a position by closing the existing position and opening a new one at the same time.

Your first adjustment should be to roll out your option to the next contract month and take in more premium. For example, if you had a December expiration option, you would roll it out to January (at the same strike price) and realize additional credit.

With more time and a higher credit on the overall position, you give yourself more time to profit while also moving your break-even points out further.

One more thing. You can also roll in the other side of the trade that is currently showing a profit. If the stock moves higher, you will roll UP the put side and visa verse on the call side; if the market moves DOWN, you would move down the call side.

Both of these adjustments will give you a higher statistical chance of making money even if the stock moves against you at first.

Final Thoughts

The release of earnings is a binary event involving significant uncertainty. Initially, this uncertainty triggers IV to spike, and once earnings are announced, IV crashes. Understanding this central concept will take the guesswork out of options trading and enable investors to move forward, build upon that knowledge and leverage profitable options strategies.

Share Your Best Earnings Trade!

It's okay to brag a little here. . .

Add your comments below and let me know what the best earnings trade you’ve made looked like. What was the setup? What strategy did you use?

Sometimes the best trade isn’t a trade that you make money on but that you reduced a loss on. If so how did you adjust it to reduce your loss? Did you roll UP in strikes or OUT in expiration months?

Here's A Quick Bonus Video Tutorial

Ever get just bearish on a stock? I know I did on JCP & QQQ a while back.

And when placing bearish trades it's important to consider the cost and the break-even points.

For example, in this video tutorial we’ll show you why our JCP trade gave us some extra “buffer” room in the stock which allowed us to take later a very big profit.

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.