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Aug 23

How to profit from Earnings announcements with options?

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If you search on the web about options strategies to apply when companies release their earnings, most of them will tell you about selling Iron Condors, Straddles, etc… This, in fact, in not entirely true. And I know this from my own bad experiences… I tried almost everything on selling high IV strategies but never reached consistency until I thought “outside the box”.

Unfortunately, many traders approach options and earnings in the wrong way, leading to disappointing results. However, with the right options strategy, earnings release season can be highly profitable for well-educated options traders. By continuing to read, you'll gain valuable insights on this topic…


Implied Volatility (IV) and Volatility Crush


Implied volatility (IV) in the options market is driven by investors' expectations regarding the degree of stock price fluctuation. Higher expected movement leads to higher IV.

As a stock approaches its earnings announcement, its IV generally increases, not because the stock itself becomes inherently more or less volatile, but due to the high uncertainty and risk surrounding the earnings release.

When volatility rises, the option premium also increases, making everything more expensive. This singular event causes option premiums to swell on both sides of the market, presenting options traders with an opportunity to sell relatively expensive options and profit from their subsequent decline in value.

On the other hand, when earnings are disclosed, the market gains a relatively clearer insight into the company's future, leading to a reduction in uncertainty. As a result, Implied Volatility reduces. This is known as "volatility crush". This fast reduction in volatility subsequently lowers the price of an option. And a trader may profit from this if he sells “volatility”…




3 Strategies that sell Volatility


Below you have a short description of top options strategies that are Vega negative (or sell Volatility) which can be applied around earnings. 

1.    Short straddles
2.    Short strangles
3.    Iron Condors

Most options traders grasp the concept of volatility crush and employ strategies that take advantage of this property. The three aforementioned strategies rely on two key factors: volatility and a range-bound stock.

1.  Short straddle

A short straddle strategy involves selling a call option and a put option of a stock with the same strike prices and expiration dates. This strategy assumes that the stock price will not experience significant movement until the options' expiration date. This strategy has an unlimited risk for both sides.

Traders using short straddles profit from the lack of stock price movement and volatility crush. This eliminates the guesswork associated with directional bets.

2. Short strangle

In a short strangle strategy, investors sell both a put and a call option of a stock with the same expiration date, but selecting strikes slightly out-of-the-money (OTM).

Short strangles limit profit potential as the credit received while exposing investors to unlimited risk. The maximum profit occurs when, upon expiration, the stock price falls between the strike prices of the sold options at expiration. By employing a short strangle, investors sell an OTM put and an OTM call equidistant from the current market price. This neutral approach minimizes the directional prediction associated with potential stock movements following the earnings release. By focusing on selling options with high Implied Volatility, the trader increases the chances of success and expects the stock not to move too much…

If selling options naked or assuming additional margin risk is not ideal, the trader can consider using the iron condor strategy.

3. Iron condor

An iron condor involves selling a Strangle (short strangle) but also buying other options (a Put with a lower strike price than the bought Put), and buying a  call option with a higher strike price than the one that has been sold. All these options have the same expiration date. Iron condors also result in a credit, providing upfront cash flow and having limited risk (by opposing the short Strangle that has unlimited risk). I the stock price remains within the range of the short strikes at expiration, the trader will profit. Opening Iron Condors in a high IV environment may benefit the trader after the volatility crush…


But, are these strategies good to apply to earnings?


I must answer with a clear “NO”!  For several years, I diligently attempted to capitalize on earnings through options trading. It seemed too easy given the predictable nature of these events: the implied volatility (IV) of options tended to be high prior to the earnings announcement and crash afterward. However, despite some years of trials, involving the sale of Iron Condors or Straddles and taking some different approach of the expected stock movement (either by assessing the price of the At-The-Money (ATM) Straddle or the Market Makers Move), I struggled to discover a consistent approach to exploit these occurrences.
  
There were occasions when I achieved significant wins, particularly when the stock exhibited minimal movement following the event. However, there were also instances where I experienced substantial losses due to wild swings in the stock price, occurring in either direction. During a long testing phase, I was unable to identify a robust strategy that could be incorporated into my options strategies arsenal, one that would deliver consistent gains (as many of you may already know, I prefer slow, steady, and consistent growth).
 
Recently, a shift in my thinking prompted me to explore a different perspective on trading earnings events that could support my trading profile (trade these events in a safer way). As a result, I started testing a new approach, which ultimately proved to be a game-changer. The key to its success lay in leveraging the IV to my advantage while implementing lower-risk and non-directional strategies. This shift greatly improved results delivering the consistency I was looking for!
  
The new approach is focused on a process to profit from a rising IV to tilt the odds in our favor. By understanding the dynamics of implied volatility and incorporating it into our trading decisions, we can navigate earnings events with reduced risk and increased consistency.
 
In short, the highly predictable property of earning announcements where there is an Implied Volatility crush is not easy to deliver profits when using Vega negative (or selling IV strategies). The earnings announcements should be traded in a completely different way that should focus on rising IV prior the announcement… And this is a game changer! 

Earnings Options Strategy Course