as you expect, but still moves up or down in
line with your speculation, the ATM vertical can still be profitable. So you may not
want to buy a less expensive O TM vertical
because if the stock doesn’t move enough, it
can still expire worthless, even if the stock
moves as you predicted.
Riskier: Iron condor when you think the
stock won’t move big
When you use an iron condor for an
earnings trade, you’re betting the stock
won’t move up or down as much as the
market expects. Ideally, the stock might
stay in between the strike prices of the
short options of the iron condor through
expiration. But if the stock moves up or
down, past the short strikes and even past
the long strikes, the iron condor will lose
money. For example, with the stock at $80,
an iron condor might be long the 77 put,
short the 79 put, short the 81 call, and long
the 83 call.
When implied vol is higher, the credit
(which is also the max potential profit) for
the iron condor is higher, all things being
equal. That’s what makes iron condors
an interesting, if riskier, earnings trade. If
the stock stays between $79 and $81 after
the earnings announcement, the trade can
be profitable. If the stock moves past the
breakeven points, which are the short put
minus the credit and the short call plus the
credit, the iron condor will lose money.
Iron condors also have defined risk, with
a max loss equal to the difference between
the long and short strikes, minus the credit
received. But if the difference between the
long and short strikes is large, the loss is
larger, too. The rationale for widening the
iron condor is to increase the credit received. This depends on your risk appetite
and how confident you are the stock won’t
have a big price change. The closer the short
strikes are to the prevailing stock price,
and the further O TM the long strikes are,
all things being equal, the higher the iron
condor’s credit. But the risk is higher, too.
That increased risk is why you’re getting a
Riskiest: Short straddle when you’re
confident the stock won’t move big
If you’re sure the stock won’t move as much
on the earnings announcement as the rest of
the market expects, and the higher implied
vol of that stock’s options have too much
premium, then you might consider selling a
straddle. For example, with the stock price at
$80, the short straddle could be short the 80
put and short the 80 call. When implied vol
is higher, the credit received for selling the
straddle is higher, too, all things being equal.
And that higher credit means the potential
profit can be higher, too. If you’re right.
On the other hand, a short straddle has
undefined risk, so you can’t measure the potential loss. And if the stock has a huge move
up or down, the loss on a short straddle can
be big, or even catastrophic. The breakeven
points of the straddle are the strike price
plus and minus the credit received. Even
a moderate stock price change can blow
through breakevens and cause a loss.
That’s why the short straddle is one of
the riskiest ways to trade earnings, but also
has the highest potential profit. It reveals
how profit and risk are linked. When the
trade’s potential profit is high, so is the risk.
IN OTHER WORDS, EARNINGS TRADES
aren’t for everyone, and their short-term
quality means they can be either winners or
losers over just a few days. Further, there aren’t many ways to adjust or manage them. So
regardless of your willingness to accept risk,
you should keep your position small so that
if the max loss does occur, you’re not wiped
out. Finally, remember that commissions can
really add up if you actively trade earnings.
But if you need to spice up your trading
with an extra dose of risk, earnings may be
something to consider.
Thomas Preston is not a representative of
TD Ameritrade Inc. The material, views, and opinions expressed in this article are solely those of
the author and may not be reflective of those held
by TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2
FINDING EARNINGS TRADES
The thinkorswim platform offers a useful tool to see which stocks’
earnings are coming up.
1— Go to the Market Watch tab and select the Calendar page.
2— You can select to see only earnings on the left-hand side.
3—Click on a date in the Calendar to review stocks with earnings
announcements on that date.