It was a breakthrough week for my options trading career and I made some pretty decent money trading earnings. In this post, I will cover how its done so you can do it yourself. Its not that difficult once you know the tricks which I have learned thanks to the expert tutlage of Henry Gambell and John Carter over at Simpler Options. Here's how its done:
1) Find companies which are going to report earnings before the next day's open - either today after the close or the next market day before the open. My favorite source is Yahoo Earnings Calendar. Stick with big, popular high priced and heavily traded stocks if at all possible.
2) Bring up the options chain and calculate the "Market Maker Move" abbreviated MMM as follows:
MMM = Cost of at-the-money put + Cost of at-the-money call
As for an example, with AMZN trading at 300, the 300 Call is asking $9.20 and the 300 put is asking $8.80. Add them together and you get close to $18 so round it up to $20. That means that the Market Makers are pricing just under a $20 move after earnings.
3) Now calculate your upside and downside targets as follows:
Upside Target = Current Price + MMM
Downside Target = Current Price - MMM
In our example using Amazon:
Upside target - 300 + 20 = 320
Downside target - 300 - 20 = 280
4) Next price some options spreads where you are shorting the calls just outside the MMM on the upside and shorting the puts just outside the MMM move on the downside. In our example:
Short the 320 call
Short the 280 put
For protection, we also want to buy the next further away option for protection since short options have unlimited (or at least very large) risk. In our example:
Short the 320 call and long the 325 call
Short the 280 put and long the 275 put
So you are basically selling a Call Credit spread above the market and a put credit spread below the market. Those familar with options parlance recognize that that as an Iron Condor. The beauty of this trade is that all the price has to do is close anywhere the 2 short strikes and the trade goes out at max profit without even a closing transaction!
5) Calculate the total premium you can collect. For a 5-dollar wide spread, you want to get a credit of at least 1/3 of the distance between the stikes for example $165 for a maximum loss of $335. If can't get a decent credit, don't take the trade. For example, I would not take a $1 credit for a max loss of $400 since the risk/reward ratio is more skewed and not in your favor.
Another cool thing about this trade is that at least one side of the trade will go out at max profit because the price can only have a single closing value. After all this is trading and not quantum mechanics!
6) If you think you can get a good enough credit, put in a limit order for the side with the bigger credit and see if you can get filled between the bid and offer also known as the natural price. Once you get filled, on one side, try agressively to get filled on the side since having both legs on actually reduces your overall risk
7) Once filled, sit back and wait for the earnings.
If the stock really pops or drops, you can take off the short option and leave the long on on which I did with some success with AAPL this week. You can always trade around a position if it moves against you.
Having traded this method several times this week, its uncanny how often the price closes within the MMM!
Here's a table of trades I did this week and the outcome:
|AAPL||395/400 440/445||+1.90||Max profit plus some due to trading around|
|NFLX||225/230 300/305||+2.03||Max profit|
|BRCM||29/30 34/35||+0.35||Max loss but does not expire until August|
|CELG||131/132 139/140||+0.35||Closed for debit of 90, loss of 0.55|
|AMZN||275/280 320/325||+1.64||Closed for 0.06 short of max profit|
I'm sticking with small volume (1 or 2 lots) until I can get the hang of this. Also, i'm trying to keep the maximum loss of on any single position less than about 1.5% of the account.
That's all, enjoy your weekend