By: Steve Smith
In this week’s Earnings360 live training session, I introduced a strategy I refer to as PEPE, which stands for Pre-Earnings Premium Expansion.
During the call, I initiated a position in JPM Morgan (JPM) — which reports earnings next Tuesday 7/13 — in order to provide an example of this strategy in action.
Many people on the call took the initiative to establish the position, with us closing it out for a solid 23% gain this morning. Those that took the trade have now paid half of the quarter’s membership fee! And, we haven’t even started yet!
For my money, I’d much rather earn 20% to 25% with very little risk than buy some lottery or YOLO calls that promise triple-digit gains but more likely end up worthless, or with a 100% loss.
Next week, I’ll get into the Post Earnings Premium Crush. However, for today, let’s drill down into the PEPE option strategy.
PEPE’s a safer and more reliable positioning path in anticipation of the implied volatility increase preceding earnings. The respective strategy actually avoids the actual event altogether. Just as PEPC is predictable, so is the premium pump-up going into the event, only it’s more subtle — occurring incrementally over many days.
The strategy I use for taking advantage of rising implied volatility, leading into earnings season, is a combination of buying and selling put and call spreads with different expiration dates. Essentially, it can be considered a double calendar spread strangle, where you sell options that expire prior to the earnings report while simultaneously purchasing ones that expire after it.
Like any calendar spread, it will benefit from the accelerated decay of the nearer-dated options sold short. But, this has an added tailwind due to the upcoming earnings release. The options will see their implied volatility rise, causing an increase in spread value. To keep the position delta neutral, put and call calendars should be established. This must be done in advance and closed before the actual earnings.
The JPM trade I made during the event was structured thus:
-Sell to open 2 contract JPM July (7/09) 150 Put
-Sell to open 2 contract JPM July (7/09) 155 Call
-Buy to open 2 contract JPM July (7/16) 150 Put
-Buy to open 2 contract JPM July (7/16) 155 Call
For a Net Debit $2.65
Here was the order ticket:
I expected JPM shares to remain between $152.50 and $155 until Friday. At that point, the weekly options premium sold short would contract while the options on 7/16 expiration would retain their value.
This morning, I alerted e360 members to close the position at $3.25 (a 23% gain).
Here’s that respective order ticket:
On a mere two contracts, that’s $120 — which pays for more than half of the quarterly subscription price (60% to be exact).
Season 15 of Earnings360 officially kicks off on Monday. Do not miss what should be a very exciting and profitable six weeks of trading.