Earnings season officially kicks off on Jan. 18 with Alcoa’s (NYSE: AA) earnings report, but much earnings news will come out prior. That is why I want to discuss the following strategy today.
Why should you care about earnings season?
It’s 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.
Earnings Season Options Strategy
Today, I want to explain an earnings season options strategy that is one of my favorites.
The assumption of the strategy is 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 this approach around earnings using a shorter-duration iron condor as an earnings season options strategy.
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 is 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 Verizon (NYSE: VZ).
The stock is currently trading for $52.53 and its earnings release is scheduled for Jan. 23.
I prefer to go out one to two days prior to earnings, but in this case, Verizon has an IV rank or IV Percentile of over 96%.
IV rank tells you whether or not the implied volatility is currently high or low.
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 knows, your preference is to always sell your product for inflated prices. Options are no different.
Knowing these factors allow you to focus on the best opportunities.
So, knowing VZ’s implied volatility is above historic volatility, we can proceed to the next step . . . choosing your return.
VZ is trading for roughly $52.50, with an expected move around earnings of $2.50.
So, knowing that the expected move is roughly $2.50, I want to first 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 $2.50.
The January 54 call strike, due to expire on the 26th, fits the bill. It has a 75.68% probability of success.
Next, I take a look at the put side with the same goal in mind.
The January 50 put strike fits the bill. It has an 76.03% probability of success.
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 5 points (54 – 50 short strikes) and VZ currently trading for $52.50, the underlying ETF can move higher $1.50 or lower $2.50 before the trade is in jeopardy of taking a loss.
Of course, the goal is to take off the trade immediately following VZ earnings. The volatility will push back to normal levels after earnings are released as the uncertainty around earnings have passed.
The Volatility Crush
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 40% if VZ 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 in my upcoming webinar. Stay tuned!