By: Steve Smith
Earnings Season is indeed upon us. Yesterday, I hosted a webinar detailing the Earnings360 approach to trading earnings reports. The first trade recommendation was issued today but there’s still time to get in and not miss any of the some 30 trades I expect to make over the next six weeks.
During the event, I explained my process and revealed the strategies of the Earnings360 service, which has been producing consistent profits for the past +4 years.
Honestly, even under ideal circumstances, earnings can be extremely tricky to trade, with many moving parts.
Will the company miss or beat expectations? What will be the guidance? Will traders “sell the news,” or buy into “the unknown,” believing the recent decline has priced in a near-worst-case scenario?
However, there’s one predictable pricing behavior that savvy option traders use to make steady profits. Given all the recent volatility and numerous unknowns, options premiums will be at record-high levels as market-makers must price options for outsized moves.
So, how do you trade earnings in a world without guidance? Here’s a quick guide that rests on taking an options-centric approach.
Use the Post Earnings Premium Crush (PEPC)
No matter what a company reports, or how the stock reacts, the options will undergo a PEPC. This is my way of labeling how implied volatility contracts, immediately following the report no matter what the stock does.
As you can see, the repeating implied volatility pattern of Netflix (NFLX) options is spiking and retreating in the quarterly reports.
You’ll often hear traders cite what percentage move options are “pricing in” the earnings. The quick back-of-the-napkin calculation for gauging the expected move magnitude is to add up the at-the-money straddle.
Once option traders are armed with this knowledge, they advance to using spreads to mitigate PEPC’s impact when looking to make a directional bet. Some will graduate to getting this predictable pricing behavior in their favor by selling premium via strangles, or the more sensible limited-risk iron condors. But, these strategies still carry the risk of trying to predict, if not the direction, then the move’s magnitude.
While the Earnings360 option-centric approach isn’t a guarantee, it does stack the odds considerably more in our favor by getting the PEPC tailwind at our back. All Earnings360 trades use some form of a spread to give us a high probability of profit while assuming a limited risk.
In my next article, I’ll describe the Pre-Earnings Premium (PEPE) to take advantage of options pricing behavior prior to the release of the report.