OPTIONS

The hallmark of a professional option trader is the ability to use a wide variety of trade structures in order to exploit opportunities to profit from specific situations the market presents, says JW Jones of Options Trading Signals.

One of the opportunities routinely presented multiple times yearly is the impending release of earnings. Underlying the logic of earnings trades is the stereotypic pattern of increasing implied volatility of options as earnings approach. This pattern is so reliably present that experienced options traders can recognize the approximate date of an impending earnings release by simply perusing the implied volatility of the various series of upcoming options.

As a real time example of this phenomenon, consider the current option chain of AAPL, which reported earnings after the market closed on Wednesday, January 23.

chart
Click to Enlarge

As can clearly be seen, the front weekly options, the first series in time following the earnings release, had dramatically elevated implied volatility as compared to the series expiring later.

It is because the release of earnings routinely causes reversion of the elevated implied volatility toward its historic mean value that a number of high probability trades can often be constructed surrounding earnings.

I thought it would be instructive to review a recent earnings trade I made in order to see how this consistently observed collapse of implied volatility works in practical terms.

EBAY was scheduled to report earnings after the market closed on Wednesday, January 16. As the price chart below reflects, EBAY had recently rallied and was trading in the price range circled in red.

chart
Click to Enlarge

NEXT PAGE: The Strategy

Tickers Mentioned: AAPL, EBAY