A Guide to Using Options to Play Earnings | stockbee

6/30/2007

A Guide to Using Options to Play Earnings

Smart Money has a couple of articles on using options to trade earnings. If you are option trader, you may find them interesting. But some of the most profitable trades after earnings are on little known companies with no options. When HANS or NTRI had first earnings acceleration, they had no options.

EARNINGS SEASON REVS up this week, and speculative trading on corporate reports will dominate the options market for the coming weeks. This is a time for investors who understand the fundamentals of stocks to use options to potentially extract extra value from their shares.

The time-honored technique for speculating on earnings reports is buying at-the-money or slightly out-of-the-money calls to benefit from an expected increase in the underlying stock price. Some speculators like to sell puts whose value will decline should the stock advance.

Both of those strategies are already evident in the market, but as this earnings season is expected to usher in a decline in earnings growth a new technique may be in order — namely the stodgy, old strategy of selling calls against long stock, which is known as over-writing.

5 comments:

ivanhoff said...

Buying an option before earnings is suicidal in most of the cases. Even for the underfollowed optionable stocks the IV is way too high due to an existince of forthcomming event, that may significantly influece the stock's price. Most people don't realize that even if their stock gaps up 5 points on earnings, they may still lose money on their call due to the declining IV after the earnings' anouncement. That's why professionals like to sell high IV and sometimes to buy low IV.
You may partially neutralize the high IV if purchase a debit spread (buying a call ATM and selling a call slightly OTM with the same expiratin date), but here you'll have to fight against 2 different bid/ask spreads, which won't give a very good return.
In options' trading equity selection is the most important ingredient only if you purchase derivatives with 6 to 12 months before expiration. Shorter term options are influenced by many other factors.(volatility, volatility acceleration, time decay).
To conclude, buying straight calls and puts before earnings' anouncement is not the smartest thing you can do.

Ben Evans said...

Trading earnings can be profitable or very unprofitable with options. Most long option trades are tough to make money....However if a person is able to pick the appropriate stock and the appropriate option, a long option trade can be successful.

There are ways to skirt the decline in IV which is what robs most option positions through an event like earnings.

For those who are long stock:

A simple ratio write is a very good strategy. Now, I do want to say that a person must have a lot of experience in options before trading this way because part of this position is naked. There are ways to hedge the naked position. This is selling volatility.

Another strategy would be to employ calenders or diagonals. These can sometimes take advantage of the decay in IV. The horizontal and diagonal trades are the most technical trades in the universe. Anyone employing these strategies must have a very good knowledge of options.

Backspreads for a credit are sometimes good. In most scenario's, however, a person would like a stock to move. If it doesn't and the stock settles between the long and the short strikes, these positions become highly lossy.

There are a whole slew of other option plays that can be utilized through and earnings event....

1) Short call or put condors
2) Short butterflies
3) Iron condors
4) Put and call debit spreads played in a combination. (kind of a reverse iron condor)

But alas many of these postions like short condors and butterflies don't provide that much premium.

The last way to invest through earnings is to play deep in the money options which hybridizes the position to mimic a long or a short position.

With all this said I tend to think that it is best not to speculate through earnings and invest in other periods. This is long, short or with options.

I wish you success with your investments/trades.

Regards,

Ben

Mike Summers said...

Hey pradeep, got any reccomendations for books to read about options?

Seems like there's a lot of different strategies... i understand athe basic of what they are, but if you have any reccomendations on books about options that talk about profitable strategies that would be great, thanks

QUIKTDR said...

Pradeep,

How would one handle multiple EP signals such as GS on daily and NYX on weekly?

Do conflicting signals cancel each other?

You mentioned GS in a previous comment. Would you buy on bullish EP signal and sell on bearish EP signal?

Often I see bullish signals followed directly by bearish, almost simultaneous conflicting signals. This says stay away to me and to you?

Pradeep Bonde said...

Weekly EP's are not valid. High priced stocks give you many false signals. EP is not completely mechanical strategy, the interpretation after signal is important. In GS and NYX case the sector was breaking down, so bearish signals were obvious.