Options Trading Strategies For Earnings Season

| October 9, 2015 | 0 Comments

option strategiesOptions Trading Strategies For Earnings Season

Earnings season is once again upon us, creating opportunities for both large gains and large losses.  As a rule of thumb, individual stocks tend to react more significantly during earnings periods than other times of the year.

The problem is figuring out which way a stock is going to move.  In other words, how are investors going to react to good or bad earnings results?

As always, picking a short-term direction of a stock can be extremely challenging.  You’re never quite sure what’s going to happen after a earnings release until it actually happens.  Will investors shrug off a bit of bad news?  Will they find a ray of sunlight in an otherwise negative report?  Is good news good enough?

That’s why it tends to be easier to decide whether a stock is going to move in general, rather than pick a direction.  Let me explain…

With options, it’s a piece of cake to bet on a stock’s movement – and you don’t have to guess what direction the move is going to take.  Conversely, you could bet on lack of movement using options, although this tends to be a riskier proposition.

Okay, so what options trading strategies are good for trading earnings?

Before I get into the strategies themselves, let’s look at an example of a stock that tends to move quite a bit on earnings days.

Here’s Amazon $AMZN:

a chart of a stock moving on earnings days, $AMZN

AMZN is known throughout the industry as a big mover on earnings days.  You can see on the chart, once a quarter, there’s a big spike in the price causing a stair-like pattern to emerge.

Now, AMZN has had a very good year for earnings results, but in the past those moves were sometimes large down moves.  The key here is that the share price definitely moves after earnings come out.

So the question is, how can we capitalize off this knowledge?

That’s where options come in.

There are two primary options strategies to use when trading during earnings season – at least if your goal is trade movement (or lack thereof).  These two strategies are the straddle and the strangle.  Follow the links for more info on each strategy.

In a nutshell, a straddle is when you buy a call and a put at the same strike, in the same expiration month, usually at-the-money.  So for AMZN, It could be something like buying the November 525 call and 525 put at the same time.  In this case, your trade makes money if AMZN moves quite a bit higher or lower than 525 by November expiration.

Keep in mind, by using November, the strategy takes into account earnings.  However, this type of strategy on a high priced stock like AMZN is going to be very expensive.  The stock will have to move over $60 at current prices for this trade to payoff.

That’s where the strangle comes in.

A strangle is the same as a straddle, except you buy out-of-the-money calls and puts instead of at-the-money.  By purchasing OTM options, the cost of the spread is going to be less.

For example, the AMZN 500-550 strangle (buying the 500 put and the 550 call) may cost about $40 instead of $60.  However, the stock has to move farther in each direction to make money.  In other words, the strangle is cheaper, but the upside is less than the straddle.

On the other hand, you could sell a straddle or strangle if you think AMZN isn’t going to react to earnings as much as it normally does.  Clearly, you’d be collecting very juicy premiums in order to do so.  However, your risk is essentially unlimited in this case and you have to have a big margin account to make these types of trades.  These are considered more advanced strategies than the buy-side counterparts.

Both straddles and strangles can be quite useful for earnings season.  The key is to not pay too much.  I like to use straddles on cheaper stocks, with more affordable premiums.  If you want to play the big moving, higher priced names, use strangles instead… just don’t buy too far out of the money.

Used properly, straddles and strangles can result in substantial profits during earnings seasons.  As always, the primary factor is doing your research and finding the best mix of risk versus return before making a trade.

Yours in Profit,

Gordon Lewis

Note: Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com.  You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.

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Category: Options Trading Strategies

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.