By: Steve Smith
Earnings season kicked off this morning this morning with reports from big banks such as JP Morgan (JPM) and CitiGroup. Both beat estimates handily and initially saw their stocks move sharply higher, only to quickly reverse. This activity highlights the challenges and opportunities for options trading.
That’s why I want to introduce you to my Earnings360 Service.
Last night, I put on a training session explaining how I take an option-centric approach and showed how I employ strategies that take advantage of the Post Earnings Premium Crush (PEPC) to produce profitable earnings trades.
One of the reasons earnings can be difficult to trade is there are many moving parts you have to get right:
1)What will the actual results be? Meaning, will the company meet, beat or miss the estimates and what type of guidance.
2) What will the reaction be? If the stock has already run up ahead of the earnings, there might be a “sell the news” response. Or an out-of-favor stock that beats expectations may shoot higher on a short squeeze, as bears scramble for cover.
3) What percentage move are the options pricing in? Option market makers know that certain stocks have a propensity for extreme moves caused by earnings reports and price the option puts and calls appropriately. This takes the form of an increase in implied volatility and the premiums get pumped up prior to the earnings report.
Post Earnings Premium Crush (PEPC)
But there is one variable that we can reliable measure, predict and profit from.
This post earnings premiums crush (PEPC) occurs regardless of the stock’s reaction up or down. The predictability of implied volatility is the single greatest edge we have in trading earnings.
Can you see the pattern of implied volatility for Netflix?
It’s not hard to guess on which dates the quarterly earnings were reported, is it!
And after Netflix reports earnings after the close Monday can you guess where the direction the yellow implied volatility line will move?
The predictable increase and then decline, or reversion to the mean, of implied volatility is what we will harness to produce consistent options trading profits.
My results over the past two earnings seasons speak for themselves.
- $500 allocation per trade
- 48 trades
- 32 Winners (66% win rate)
- Average gain of 81%
- Average loss: 42%
- Total profit: $5,450
One of the reasons I expect this earnings season to be especially profitable is that we have now entered into a higher volatility environment, which will give us an even larger PEPC. This will provide for very attractive risk/reward set ups.
I anticipate being able to unearth 3-4 trades per week in which I will spell out the exact entry and exit points and will recap each week with a live Webinar on Fridays. Good luck in your own options trading, and have a good weekend.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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