Education

Trading earnings with options

(Last Updated On: 14. December 2020)

 

earnings trading

Four times a year, there is a possibility for all options traders to generate quick profits by trading options. This type of trading is called earnings trading and it’s indeed a profitable one. But as every coin has two sides, it’s not suitable for everyone, and for inexperienced traders it might involve higher risks. Therefore, I’d like to give you a general introduction into earnings trading and also show you the catch of it. What is earnings trading with options?

Public companies are obligated to publish their earnings (or losses) on a quarterly basis. And after they published the numbers, the price of a stock can be very volatile which can cause temporary price drops. To protect themselves from losses, a lot of professional market participants are buying options for hedging purposes. The closer the day of the earnings announcements the more they are willing to pay what you can see by observing the implied volatility.

And there are of course a lot of people are willing to sell options. The most of them are selling options on the very last day before the earnings announcements because on that day, the implied volatility is usually very high. Doing this, they are able to generate a real high premium.


What’s the secret behind earnings trades?

As you have read the first section, you might already know the answer. As the earnings announcement gets closer, implied volatility tends to increase. After earnings are published, the uncertainty vanishes which causes a crush in implied volatility over night if you will. So an option which was pretty expensive yesterday is almost worthless after the earnings announcement.

In other words, when you would sell an option for $100 today before earnings, it could be worth of just $5 tomorrow. So your profit would be $95 after just one day. A pretty easy way how to earn money with options quickly, right? Well, it’s not as simple as you might think.

You would indeed make money quickly with earnings trading if there weren’t a thing. This thing is the random movement of the stock price just after the announcement.

Imagine, you have sold a put option and got a real good premium for just one day being in the trade. But as a lot of stock prices are reacting pretty volatile, it could happen, that the stock price will land deep in the money of your sold option and would cause a bigger loss than you might expect. This usually happens when the earnings miss expectations of the analysts. But there are also confusing situations when the earnings exceed the expectations and stock’s price plunges, nevertheless. This behavior applies to both sides – the put and call options as well.

Therefore, earnings trades are not suitable for everyone as they contain high amounts of uncertainty and random movements. Nevertheless, it can be an interesting way to stay engaged when markets are not giving us opportunities elsewhere.


How to make money with earnings trades – general possibilities

There are really a lot of different strategies out there how to make money with trading options during earnings announcements. Each of those strategies is different and has for sure its right to exist. But as this article is about general information, it would go far beyond the scope to explain every single option trading strategy.

If you would like to know more about the strategies in detail, it’s not difficult at all. You just need to google it or watch some videos about it on YouTube and you will get tons of information about earnings trading strategies.

And that’s actually not the important thing to know every trading strategy. What is more important, is to know how to make money with options during the earnings announcements in general. To delve into a specific strategy is just the consequence of the knowledge how to benefit from options trading during the earnings time.

There are actually two common known possibilities and an “exotic” one because it seems to be overlooked:

  1. Sell options at the day before the earnings announcement
  2. Buy options long before the implied volatility starts to increase
  3. Buy options at the day before the earnings announcement

Checking the methods more detailed

Selling options at the day before the earnings announcement: in this case you would profit from a (very) high implied volatility which makes an option pretty expensive although it might have just one or two days before expiring. In this case you will get real good premium being in the trade just one or two days.

Buying options long before the implied volatility starts to increase: when you buy an option several weeks before the earnings announcement, you could profit from an increasing implied volatility. So you could earn money buying an option even when the stock’s price won’t move. All you need to do is to wait and to observe the implied volatility increasing. The negative aspect of it is that you need to spend money first before you earn. Of course, this concept applies not to every single stock. You need to know in advance which stocks are tending to get high implied volatility before earnings announcements.

Buy options at the day before the earnings announcement: this method is actually an “overlooked” one and seems to be not as well known as the two others. The idea behind this method is to say: “I know that I will pay much more for an option than I would pay for it a couple of weeks before the announcement. But statistically, there are more surprises in the markets than not, which will lead to the fact that I will get rewarded by those hefty movements of the stock’s price”. According to a study from the year 2013, this method works best when you buy straddles. An important thing to mention: This method requires a special approach on a stock selection because not every stock is suitable for this method.

Please note: This was a brief introduction of the possibilities how to trade options during the earnings time. But please, don’t start to trade options just by taking this information because trading options during earnings time is an art of itself. Even if you already have some experience in a regular trading with stock options: You need to delve much deeper into the whole topic of earnings trading and get familiar with the strategies and set-ups within those three possibilities I explained above.

And even then, there is still a catch around options trading during the earnings announcements which I will explain you in the next section, folks.


Where’s the catch of earnings trading?

As I already explained that the stock’s price moves randomly at the day which is a risk, you might think this is the catch. But no, this is not the real catch because with a right strategy suitable to your mentality, you would deal with those random price movements. Therefore, take this, folks:

Statistically, earning money with options during the earnings period works very well and you can generate a real profitable (additional) income with it. But in my opinion, in this type of trading the most private option traders underestimating the trading frequency. And this applies especially for the possibilities 2 (selling options) and 3 (buying options the day before earnings).

During this short period of about 4 – 5 weeks, you need to set up indeed one trade after other. And I mean not one trade a day, but at least 10 trades a day!

Why? Because you need to generate a high number of trades to compensate the loss outliers. Those ones which generate huge gaps and tear bigger losses into your account if you wouldn’t set up a high number of trades.

What does it mean for you? Well, you need to spend a lot of time to set up trades and also to manage them. You need to sit in front of your computer every damn morning on schedule just before the trading session starts to manage the trades you opened the day before. And then, at afternoon, you need to prepare the next trades.

And that’s the main catch for private traders – having enough time and the endurance to pull the strategy through. The reason for this is that the most private traders usually have regular jobs, and the time factor would be a problem for them. That’s the main catch.

But there is another one, though it might not apply to every private trader:

In all three cases you also would need a suitable money account. Because to do a lot of trades per day, you need an appropriate account size to buy all these options or to serve the margin requirements when you sell options. Therefore, if you would like to trade with options during earnings time, you should have an account of $50.000.


Conclusion:

So let’s summarize, folks. Is it worth to trade with options during earnings announcements? The answer is clear: Yes, it is!

But to do this, you need to strictly follow those guidelines:

  • Traverse the whole topic deeply and choose a strategy (or more, if you want). But it’s important that you gather as much as possible information about this type of options trading, and that you test your trades intensively before you try them with a real money account
  • Make sure you keep a high trading frequency during this short period of time to compensate the losses. If you don’t have the time and the patience then don’t do this type of options trading
  • Make sure you have an appropriate account size either to serve the margin requirements or to have enough money when buying options

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