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Trading Options Over Earnings: How to Mitigate Your Risk & Secure Profit

Stock market earnings season- A quarterly recurring period of time where even the most disciplined of traders occasionally tickle their gambling itch in hopes of hitting it big. What is it that draws so many traders to take the risk and gamble over a company’s earnings report (ER)? Akin to winning the lottery, correctly guessing the direction the stock will move over a company’s ER can result in a windfall of profit when utilizing the correct options contracts.

That being said, playing directional options (naked calls or puts) over earnings can only be considered one thing: gambling. This is due to the inherent risk with holding options over an earnings report, which for many traders becomes a “feast or famine” position to hold. While those that occasionally get lucky from time to time with this style of “trading” will often refer to themselves as experts, this self proclamation couldn’t be further from the truth.

There has got to be a better way to capitalize on these large earnings report moves, right? By analyzing historical earnings report data, we are more accurately able to infer a company’s stock price reaction to earnings. There are a number of metrics that are useful and important to look at when evaluating a company for an earnings trade. These include:

  • Actual Stock Move: Whether the price of the stock had a positive or negative reaction to the earnings report; and what percentage that move was

  • Current Implied Move: Calculates the magnitude of the expected move over earnings. i.e. what percentage investors are expecting the stock to move

  • Average Implied Move: The historical average of all the implied moves over earnings

  • Average Actual Move: The historical average move of the stock price over its earnings report

In this graphic, showing historical earnings data for Target ($TGT) we can see all of the previously mentioned suggested metrics.  Photo courtesy of the Opinicus Holdings’ Trader’s Thinktank

In this graphic, showing historical earnings data for Target ($TGT) we can see all of the previously mentioned suggested metrics. Photo courtesy of the Opinicus Holdings’ Trader’s Thinktank

The above graphic gives visual context to the metrics we are looking for when scanning for a potentially profitable earnings trade candidate. Before getting into the requirements and ranges that we look for within the historical earnings data metrics, it is important to discuss the particular strategy that we use.

The preferred options strategy to use when trading over earnings is a straddle. A straddle entails buying (“going long”) call and put contracts at the same strike and expiry. The straddle is useful to use when we as traders are expecting a big move in the underlying stock, but don’t specifically know which way the stock will go. You may be thinking, why do we need to look at historical earnings data when we can utilize a strategy that is profitable with a big move in either direction? Well, there are some additional complexities to consider when placing our straddle. For example, if a particular stock is a “non-mover” (meaning it stays relatively flat) over its earnings report, both legs of our straddle (the call leg and put leg) would end up being at a loss the next day. This loss would be mostly attributed to a phenomena known as implied volatility (IV) crush, but that is a topic for another time. That being said, we look to historical earnings data to increase the probability that our straddle will be profitable.

The first and most important metric to look at with our historical earnings data is the average actual move over earnings. We want to see a minimum of a 10-12 percent average move over earnings, but ideally closer to 15 percent. This is the most important metric to consider when placing our trade, because the underlying stock move must be great enough to cover the losing leg of our straddle trade. Remember, we are buying both calls and puts, so one of those is going to end up being a loser. The gain we receive must be large enough to cover the losses. Finding stocks that move an average of 15 percent or more over earnings is the secret behind this strategy. To see this idea put into use in a real trade, scroll down and watch the video covering the $SKX trade over earnings we placed.

The team at Opinicus Holdings provides institution level historical earnings data research to the members within the Trader’s Thinktank during earnings season, including access to the visual historical earnings graphic similar to the one shown above. Click here for a free trial to this service and experience many of the other benefits first hand.

Now that you know what historical data parameters to look for, and what strategy to utilize to capitalize on the large moves - you must still remember that taking an options position over earnings still has increased risk. Even though the odds are in our favor when we utilize the data paired with this strategy, there are still times when the stock can be a “non-mover” and end up in a loss. Keep this in mind if you proceed with this strategy!

Finally, be sure to check out the video below to see an actual real money example of how this type of trade was put on.

If you learned something new in this article, please comment below!