Earnings are typically an amazing time to sell elevated levels of premium in options. The uncertainty that surrounds an earnings announcement will cause the market makers to pump up the options pricing months in advance and, with the more recent broad market volatility, it is juicing up the prices as if they were getting ready to jump on a bodybuilding stage.
If you’ve been around options trading for a while you know the typical way to trade earnings is to sell out-of-the-money options and basically create iron condors, short strangles and straddles.
The thought behind this is that the expected move, which can be found by taking 85 percent of the money straddle price in the expiration cycle immediately following earnings, and that will cover the post earnings move in the underlying security about 68 percent of the time. Yet it’s the other 32 percent of the time where options prices can explode well beyond the expected move and leave the options sellers as the big losers on the trade.
With these issues in mind, I was on a mission to find a couple of different alternatives to trading earnings. Today I present two “nontraditional” ways of trading earnings with options I have had recent success with.
The first alternative I want to present is actually buying a long strangle.
Now I know what you’re thinking, “Why would I do that, why would I buy a strangle that’s a low probability trade?”
I just had recent success with this in a Morgan Stanley strangle where I bought the 41 put in the 46 call and by the end of the week, the price of Morgan Stanley had jumped up to more than $48, so it was quite a profitable trade. I wouldn’t have been able to profit and even would have had losses had I sold the strangle.
Typically I wouldn’t have put on this trade because of the low probability nature of it, but having seen the option prices, I went ahead anyway. The entire trade was only $22. It was so inexpensive I thought, “Why not try it and see how goes?”
And that worked out pretty well.
The key to success with buying the strangle is recognizing when the price of the earnings trade is too low to sell the options — maybe it’s the right time to buy the trade instead. I would have never sold the trade for just a $22 credit, but to play the earnings lotto and risk just $22, that doesn’t seem like too bad of an idea occasionally.
This is not something I would always recommend but it is another tool you can put your toolbox if you see that option prices are low, Rather than selling the strangle maybe you could buy one…
After the Announcement Credit Spread
The second strategy that I’ve used in the past that’s worked pretty well is after the earnings are announced, and you see which direction the trade may run, putting a credit spread to follow that trade.
I’ve done this before on Netflix where it decided to run up after earnings. Immediately after earnings, like within the first 20 minutes of the market opening, rather than scrambling to take off an iron condor from the previous session, I put on an at the money put credit spread. The next thing I know an hour later, that put credit spread had lost half its value and I was able to take it off very quickly for profit.
The key with this setup is to observe where the trade is headed and sell the option premium while it is still relatively high. The prices won’t be as high as at the close of the preceding session, but it should still be expensive enough to justify taking on the short-term risk.
Now, there’s every chance the underlying could still turn around, but hopefully by the time that happens, the options pricing will have come down enough where you could bail and keep a little bit of the premium that you sold.
After you see which way the stock is moving and you feel confident it will continue to go on that way, this is another strategy you could use where you are putting on a credit spread and then taking your profits within maybe just an hour or so, following the trend of the market.
I know these two strategies may be controversial to many options traders.
But at the same time, they’re two different ways to trade earnings that I have been able to profit with. They won’t work every time of course, but if you’re able to watch your trades and make fast decisions, which is how you have to trade earnings, these could be a couple of trade setups you might want to add to your trading tool kit.
Christopher M. Uhl, CMA, MOSM
Host of the Wall Street Report, The Fastest News in Finance
Host of the How to Trade Stocks and Options Podcast
Trading Writer for MoneyandMarkets.com
Founder, CEO and Head Trader of 10minutestocktrader.com