Two Ways to Trade Earnings with Options

Earnings season can offer good opportunity for options traders.

Unfortunately, buying options ahead of earnings may not be the best strategy, some traders have warned. “The uncertainty surrounding an earnings release creates a huge bid for implied volatility ahead of the release. Once the earnings come out, volatility drops, and this can hurt long options positions,” notes CNBC.

As we all know, options premiums can fluctuate significantly going into earnings. Then, once earnings are released, things can get really wild when volatility pulls back.

The challenge is to figure out how to end up on the right side of the trade.

One way to reduce risk is to use spread trades, whereby a trader sells options and buys options. Overall, this reduces your exposure ahead of a highly anticipated event, like earnings. For example, a popular strategy is to use an at-the-money vertical spread by buying an in-the-money option and an out-of-the-money option using the same expiration. Both strikes would also be the same distance from the underlying stock price.

Other traders suggest using an options straddle.

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Goldman Sachs for example recommends using this strategy, which involves using a call and a put contract. Such a strategy ultimately makes money as long as the underlying stock sees a significant move, regardless of direction.

When setting up a straddle, some will enter it at least three to four weeks in advance with an idea that they’ll see price movement in anticipation of the event.  In any event, you may want to establish a straddle at least a week prior to earnings.  For example, let’s say Apple was nearing earnings, and we wanted to use a straddle.  With the underlying stock at $175, we could straddle with an Apple February 16, 2018 180 put and the AAPL February 16, 2018 180 call.

While there are a few ways to trade earnings with options, remember it can be a very tricky bet.  In fact, over the last 20 years, I’ve been just about everything happen with earnings.

  1. The company beat earnings, but lowered forecasts for the next quarter.  Instead of an expected gap higher, the stock plummets
  2. The company misses earnings, but posted higher than expected growth for the next quarter, and the stock pushes higher.
  3. The company beat earnings quarter over quarter, but missed this quarter’s “expected” numbers, and sells off.
  4. Or, the company made a mess of earnings, but perhaps didn’t miss expectations by much and trades higher on the idea that maybe the company isn’t losing as much as thought.

It’s enough to pull your hair out at times.  After 20 years of trading catalysts like earnings, I’m shocked I still have hair left. 

While trading earnings with options can be a risky bet, be safe if you trade it.

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