Successful options traders share one commonality: They all follow a quant-based approach.
Years ago, I never thought it made sense to trade earnings. It was a mostly a foreign concept and due to numerous limitations, trading earnings announcements just didn’t make sense from an efficiency standpoint.
Well, things have changed.
Add 52 weekly expiration cycles and a variety of highly-liquid products and the clarity of a once-unknown calculation . . . and we now have the opportunity to trade earnings news in an efficient and informed manner.
The unknown calculation? Expected move.
What is expected move?
It’s the price movement the market expects during a given expiration cycle. It’s the key to successfully trading earnings announcements. Fortunately, now we have tools that allow us to see, in real-time, the expected move for any given underlying stock around an earnings announcement.
Let’s look at an example using Netflix (NASDAQ: NFLX), which releases earnings on Monday, Oct. 16.
As expected, implied volatility (IV) is high as we move closer to the uncertainty of the NFLX earnings announcement. We ALWAYS want to see heightened levels of IV when seeking trading opportunities around earnings. Increased levels of IV means inflated options prices . . . basically, that we can sell options for more premium than usual.
We have several tools at our disposal to figure out what the expected move is for Netflix immediately following the company’s earnings announcement.
The easiest way is to just look at your trading platform. As you can see, the expected move for NFLX is roughly +/- $16.28 by next Friday, according to the Thinkorswim platform.
You can see the expected move embedded in the options chain on the Tastyworks platform.
If you don’t have access to a platform with this information, you can calculate the expected move by taking the credit of at-the-money straddle, in this case $16.25, and multiply it by 0.84. This gives you $13.65. Then take the $13.65 and divide it by price of the stock, in this case $195.96. This gives you a percentage move of 6.97%. A 6.97% move in NFLX is roughly +/-$13.65.
Knowing the expected move is $13.65 gives us the opportunity to utilize a variety of strategies based on our market assumptions in NFLX (bullish, bearish or neutral).
I tend to stick with risk-defined, neutral-based strategies like iron condors.
For instance, if we know the expected move in NFLX, we can create a range-bound trade around the expected range as seen in the options chain above.
We could sell a 2.5 strike wide iron condor at the 212.5/215 – 180/177.5 strikes for roughly $0.95.
Our short strikes of 212.5 – 180 gives a fairly wide range of $22.50. And as long as NFLX shares trade within that range immediately following the company’s earnings announcement, we should be able to buy back the spread for a nice profit due to volatility crush.
The probability of that occurring is roughly 78% on the downside and over 80% on the upside. The uncertainty (and associated risk) of the binary event will have passed and volatility will immediately push back to normal levels.
The decline in volatility affords us the opportunity to take advantage of some nice profits. They call it volatility crush and I’ll show you exactly what this means (click here).
Just remember: When trading earnings you should use a small, consistently defined percentage of your capital per trade, as the strategy is inherently more risky due to the binary nature of the trade.
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