[Editor’s Note] Last Friday, I had a chance to ask our Chief Trading Strategist, Andy Crowder, about his investment strategy for trading earnings announcements that has generated eye-popping gains in only 24 months.
The following is a transcript of our discussion.
IAN: Well, this is really exciting. Every investor knows that earnings season is a big time for stocks and the market
As a trader, you don’t really care WHAT a company says in its quarterly financial report. Yet, you’ve found an interesting and profitable way to trade these announcements. Tell me how you decided to start trading during earnings season. More importantly, how has the strategy been working?
ANDY: OK, well, let’s start with your last question.
Since our first trade back on Oct. 26, 2017, we’ve had a total of 70 trades (55 winners, 15 losers) with a win ratio of 78.6%. Average returns are 7.9% per trade, with a cumulative return of 553.8%.
I’ve been incredibly pleased with the results so far and even more so since I fine-tuned the investment strategy slightly.
The first three trades were chicken iron condors, which means a tighter range. But in return for the tighter range, I was able to receive more premium. They were all losers. So, since Nov. 11, 2017, shortly after we started the service (and I altered the strategy to wider iron condors with over an 80% probability of success) my cumulative returns are 687.8% with an average return of 10.3% per trade. Win ratio is 82.1% (55/67).
There is no doubt that I have been pleasantly surprised by the results. The sample size is solid, the win ratio is tremendous and most importantly, the strategy is making money. And I can’t emphasize enough that proper position-size is the key to successfully trading this strategy. Be realistic in your expectations . . . don’t be greedy.
As for your question regarding why I decided to use this investment strategy around earnings announcements: Well, we know that earnings announcements are binary events. They are either positive or negative.
Inherently, due to the uncertainty that surround each earnings event, options prices are inflated because of a spike in implied volatility. Increased volatility increases options prices, and thereby opportunities, for those of us who sell premium.
It’s all about exploiting the spike in implied volatility.
Implied volatility (IV) essentially ramps up in the near-term expiration cycle just before earnings are reported. The goal is to capture the peak in IV prior to earnings for optimal trade entry.
After earnings, implied volatility declines, in most cases, significantly. This is known as “volatility crush.” When trading options on earnings, this is a big positive. In fact, with most premium selling strategies, volatility crush is almost always desired.
IAN: Why start trading these strategies now?
ANDY: We know through extensive research that roughly 80% of the expected move around earnings is larger than the actual movement of the stock.
Simply stated, expected move is the price movement the market expects during a specified expiration cycle. Fortunately, we have tools that allow us to see, in real-time, the expected move for any given stock and expiration cycle. But, for the moment, we are only concerned with the expected move around an earnings announcement.
Couple the larger expected move around earnings with an inflated options price due to the uncertainty around the event and you have numerous opportunities for selling premium over the short term.
IAN: Are you trying to predict WHAT is inside a company’s earnings reports? Or does that not really matter?
ANDY: It doesn’t matter at all. Again, we are trading math here. In this case, we are trading based on the expected move of the stock around earnings.
At the beginning of each week during earnings season I will send out a report. The report contains the upcoming earnings for notable, highly- liquid companies.
The report also contains the implied volatility and IV rank of each highly liquid stock.
IV rank tells us if current implied volatility is high or low in an underlying asset based on the past year of IV data. For example, if a stock has had an IV between 40 and 80 over the past year and IV is currently at 60, the stock would have an IV rank of 50%. Typically, we look for an IV rank above 50 when seeking an earnings trade.
IAN: How do you decide WHAT stocks are best for earnings season trades? How about a couple of names that you’re planning to trade in the next couple weeks?
ANDY: Besides a heightened IV rank comes liquidity as seen through a tight bid/ask spread. We want to be able to get in and out of the trade with no issues . . . especially when trading around earnings.
IAN: What types of gains could traders expect? How active do you expect to be during earnings season?
ANDY: Using this investment strategy, I expect to make anywhere from 10 to 20 earnings season trades during the period. I know, it’s a wide berth, but it’s hard to predict exactly how many trades I will place over a given earnings season due to a variety of factors such as liquidity, implied volatility and IV rank.
IAN: Thanks for your time today!
Honestly, I’ve never seen anyone taking Andy’s diligent and mathematical approach to trading during earnings season.
Most folks I’ve met simply try to GUESS about whether a company will hit Wall Street expectations . . . and then they make a trade.
Anyone who has met Andy knows that he doesn’t play that game.
It’s all about the numbers . . . probabilities . . . and putting the odds in your favor.