Next Wednesday, Boeing (NYSE: BA) reports earnings . . . creating an amazing trade setup.
My earnings trading strategy could deliver gains of 54% to 83%.
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Here’s the best part: whether you are BULLISH or BEARISH on earnings . . . you could capture these quick gains.
These two strategies are the best directional plays ahead of an earnings announcement in a highly liquid stock.
We know from previous discussions that implied volatility increases dramatically on a stock ahead of earnings. The short-term spike in implied volatility creates a short-term spike in the price of the option.
So, let’s take a look at Boeing (BA).
As you can see in the chart below, Boeing’s implied volatility is the highest it’s been in 90 days.
As expected, implied volatility (IV) is high as we move closer to the uncertainty of the Boeing 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, we can sell options for more premium than usual.
But, implied volatility alone doesn’t tell us how the current spike implied volatility compares to the average level of IV over the past 12 months. We need to look at the IV Rank for that information.
With a look at the following table of BA, you will quickly notice that the stock, with earnings in six days, has an IV rank of 95.4%. So, in this case, BA looks to be a promising opportunity due to the heightened levels of IV (highlighted in yellow).
You could also look at the IV percentile. IV percentile is a measure of implied volatility vs its past values. This is best explained by an example: If BA’s IV percentile is 98% (which it currently reads) it means that current IV value is higher than 98% of previous values.
Both are good measures and equally weighted when searching for trading opportunities around earnings events.
So, now that we know Boeing is offering a good opportunity to sell some premium, I want to dig into my favorite directional strategies by discussing a few potential trading opportunities.
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BA is currently trading for $259.04. Over the past 64 earnings cycles BA has an average gain of 1.1%. When looking at the last 10 cycles BA has an average gain of 0.15%.
For this example, we are bullish on BA post-earnings. As a result, we will use what is known as a bull put spread.
Because I am bullish in this example, I want to sell a put at a strike slightly lower than where the stock is currently trading (roughly $259).
But exactly which strike? Since I am directionally bullish in this example I want to go with the strike that is slightly out-of-the-money.
As you can see from the option chains above, the 257.5 strike meets my requirements.
We can sell the 257.5 call strike and buy the 255 strike for a net credit of $0.87. Our return on the trade: 53.4%.
Basically, as long as BA stays above our short strike at expiration, we will reap the entire premium of 53.4%. There is a 53.19% probability of success that the price of BA will stay above our short put strike of $257.50 immediately after earnings are announced.
Again, BA stock is currently trading for $259.04. Over the past 64 earnings cycles BA has an average gain of 1.1%. When looking at the last 10 cycles, BA has an average gain of 0.15%. That being said, you are currently bearish on earnings. As a result, we will use what is known as a bull put spread.
But exactly which strike should I choose? Because I am bearish in this example, I want to sell a put at a strike slightly higher than where the stock is currently trading (roughly $259).
As you can see from the option chains above, the 260 strike meets my requirements.
We can sell the 260 call strike and buy the 262.5 strike for a net credit of $1.13. Our return on the trade: 82.5%.
Basically, as long as BA stays below our short call strike of 260 immediately after BA’s announcement, we will reap the entire premium of 82.5%. There is a 54.07% probability of success that the price of BA will stay below our short call strike of $260 immediately after earnings are announced.
What About Risk Management?
Earnings announcements are binary events. They are either positive or negative.
Because we are making short-term trades based purely on binary events, risk management as seen through strict position-size is essential for long-term success. In fact, since the trades have little to no duration, there is rarely time to adjust a trade. As a result, position-size is key.
We know through extensive research that roughly 80% of the expected move around earnings is larger than the actual movement of the stock.
Remember, we are trading math here. It’s all about allowing the probabilities to work themselves out amidst the iron condor strategy, knowing that if the statistics play out, our wins should far outweigh our losses.
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