Earnings season is in full swing and many traders are looking for potential profits when those earnings reports come through.  But some strategies really may not be the appropriate way to trade a stock that potentially is about to move big.  Here are a few things to keep in mind when trading throughout the earnings season.

The first thing to realize is that everyone knows the earnings report is coming.  So what does that mean?  For starters, the stock is most likely expected to move more once the earnings report is released, and this bigger potential movement gets priced into the options.  Higher implied volatility equals bigger expected range.  Bigger expected rang equals higher implied volatility.  Any vega-positive trade, such as calendars, straddles and strangles, are at high risk for the inevitable drop in volatility after the earnings release.

Look at PCLN, which released earnings last night, and this morning is up $50.



The ATM calendar trade lost.  The ATM strangles lost.  The ATM straddles lost.

I've said this a million times, but it needs repeating:  "I believe that volatility is so fairly priced heading into an earnings event that's it's hard to make money on either side, that is, guessing the stock will move, or that it won't move."  Here, if you traded a calendar thinking the stock wouldn't move very much, you lost.  If you bought a straddle or straddle thinking it would move enough to be profitable, you also lost.

This doesn't mean, however, that opportunities don't abound.  They do.  We've been finding them here at Options Buzz:

AAPL calendar  +50% in two days
IBM calendar +51% in two weeks
GMCR butterfly +340 in two days
TSLA butterfly +199% in two days

What's needed is a thorough understanding of how volatility impacts different months and strikes through the event; being able to price your trade after the release and the vol crush.  Throw in a little experience, and maybe a little luck, and the opportunities appear.

Check the volatility of the specific strikes you're looking to trade.  Price them before and after an earnings event, when you know the vol crush is coming, by using past data.  It's by no means a guarantee of what's going to happen, but it's a decent guide.  After pricing your trade after the vol drop, then you can see how much the stock can move, or needs to move, to make your trade profitable.  Now you can make smarter decisions.

Trade safe!

Greg Loehr

 

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