Before I begin, I want to invite you to my service Earnings Season Trader. I just locked in our first two gains of the new earnings season in JP Morgan (NYSE: JPM) and Wells Fargo (NYSE: WFC). I will be introducing an abundance of new trades starting next week. I’ll begin with Netflix earnings and several others.
Since we introduced Earnings Season Trader a $5,000 portfolio, trading $500 per trade, could have had returns of $1,217.50 or 24.5%. Obviously, if you dedicated more capital per trade the returns would be even greater, but I wanted to show a conservative estimate, particularly for those of you with smaller accounts who don’t want to take on unnecessary risks.
I encourage all of you to take a look at the strategy. Simply stated, it works! Check it out here.
Earnings season is just ahead. Netflix (NFLX), American Express (AXP), and Microsoft (MSFT) are all reporting earnings next week.
And I have a good idea of where their stocks are headed . . .
How? Look no further than the options market.
The wonderful thing about options, unlike other financial instruments, is that equity options live in a competitive marketplace.
When you look at options on say, futures products, you end up with maybe one or two major market-making firms doing business.
In comparison, in the listed equity options marketplace there are generally seven to 10 major market-making firms and another 20 to 50 smaller firms (depending on the product traded) over seven different exchanges.
This equates to an incredible amount of efficiency in the options market. Indeed, it so efficient that we can accurately predict the expected move of a stock’s price in most cases.
Is this the perfect strategy? Of course not.
But does it work when there’s an earnings report during the week of expiration? Pretty damn close. In fact, the closer to options expiration, the more accurate the expected move.
So, if you pair the market’s expectation (from the option price) with what you think is likely to come from an earnings event, you can begin to decide which strategy fits the expected move of a stock.
Let’s take a look at how we calculate the expected move and what we expect out of NLFX after Netflix earnings are reported.
Expected Move Calculation = (at-the-money call + at-the-money put + out-of-the-money call + out-of-the-money put)/2 or ATM Straddle + OTM Strangle/2.
There you go. I am not going to elaborate on the formula; I just want to get it out there for you to play around with. We can easily bypass the formula and just look towards our trusty platforms.
Netflix = $365 to $435
So, what can we do with this information?
As an option trader I can use this calculation with a strategy I use known as an Iron Condor. This is a range-bound trade and one that I like to use during earnings season with stocks that have high implied volatilities.
Netflix fits the bill.
The implied volatility for July options is close to 53%. That is exactly what I want to see – inflated options prices. One way to tell if they are inflated is by looking at IV rank. In Netflix’s case the IV rank is 70.3%. Perfect. We like to see the IV rank of potential trades above 50%.
So, if I wanted to sell a far out-of-the-money iron condor on NFLX, I would take the expected move or expected range of $365 to $435 and look to sell strikes outside of the expected range.
With NFLX trading at $400, the range would be roughly $360 to $400.
I will be sending out the trade to subscribers on Monday, so if you are interested please join Earnings Season Trader here. The track record speaks for itself.
Editor and Chief Options Strategist