Earnings season kicks off on Oct. 18 with Alcoa (NYSE: AA) reporting earnings.
My brand-new trading strategy is DESIGNED to help you profit from earnings volatility.
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Why should you care about earnings season?
Because earnings season brings uncertainty. Uncertainty around earnings releases means an inflated implied volatility (IV) around the event. An inflated IV means an abundance of opportunities for those who use high-probability options selling strategies.
Today, I want to go over one of my favorite options strategies for earnings season.
The assumption of the strategy is basically neutrally-based, although there will be the occasional skew towards a bullish or bearish move.
Most of you are used to hearing about my 60-day iron condors, but today I want to discuss how I use iron condors around earnings using a shorter duration iron condor.
As with all iron condors, we have the ability to choose our return. Just keep in mind, the higher your expected return, the higher the risk.
Here’s my step-by-step approach to iron condors around earnings.
First, a disclaimer of sorts. If you don’t understand the terminology, don’t be discouraged. Focus on the concept. Pay attention to the numbers, you’ll learn the terms with repetition.
The first requirement when trading iron condors is making sure you are using a highly liquid stock. Highly liquid, in the options world, just means that the bid-ask spread is tight, say within $0.01 to $0.10, at least in most of the stocks I trade.
For instance, take the heavily-traded CSX Corp. (NYSE: CSX).
The stock is currently trading for $55.46 with an upcoming earnings release of Oct. 7.
This can be verified if you just look at the IV for a variety of upcoming expiration cycles. As you can see the IV for the Oct. 20 expiration cycle is heightened at 36.66% and has an expected move of roughly $3.08.
A normal-to-high IV rank and percentile just means you can sell options for fair to inflated prices, and as anyone who sells anything for a living, your preference is to always sell your product for inflated prices. Options are no different.
Once I’ve established the underyling I wish to trade, in this case CSX, I then move on to my mean-reversion indicator, otherwise known as RSI.
RSI can be seen below the CSX chart above. You’ll notice peaks (overbought) in green and valleys (oversold) in red. I want to place a trade when the indicator is in between those areas. It’s called being in a neutral state.
But, just being in a neutral state isn’t necessarily enough to warrant a trade.
As I said before, an appropriate implied volatility rank or implied volatility percentile is also needed.
Without going into great detail (I’ll save that for my upcoming webinar), the IV rank and IV percentile simply tells us if the implied volatility is high or low in the highly liquid stock or ETF that we want to trade.
So, knowing CSX’s implied volatility is above historic volatility, we can proceed to the next step . . . choosing your return.
Again, SPY is trading for roughly $52, with an expected move around earnings of $3.
First, I look at the call side of the iron condor, also known as a bear call spread. I want to find the short strike that I outside the expected range of $3.
Next, I take a look at the put side with the same goal in mind.
So, right now I have my starting range established. Obviously, I can alter it as needed, but first I want a good base for my iron condor trade.
So, with a range of 6.5 points (49 – 55.5 short strikes) and CSX currently trading for $52.28, the underlying ETF can move higher $3 or lower 3% over the next days before the trade is in jeopardy of taking a loss.
Of course, the goal is to take off the trade immediately following CSX earnings. The volatility will push back to normal levels after earnings are released as the uncertainty around earnings have passed.
This allows us to benefit from something called volatility crush, a powerful concept that I will discussing in my upcoming webinar.
This iron condor trade will make 20% to 30% if CSX is within the established range immediately following earnings.
Position-size is of the utmost importance when making trades around binary events like earnings. Stay disciplined and you have the possibility to have great long-term success trading around earnings.
I will be covering my management of the strategy along with several new strategies for trading earnings over the next few weeks. Stay tuned!