Trading an Earnings Phenomenon

09/29/2020 10:00 am EST

Focus: STRATEGIES

Danielle Shay

Director of Options, Simpler Trading

Today, let’s focus on an earnings trade I made with Costco. This trade is a little bit different from the normal directional momentum trades that I do, states Danielle Shay of Simpler Trading.

Why do I like earnings trades? Because they provide overnight opportunity.

Here’s how to make easy money, while you sleep...

Background Work:

When I’m looking to do analysis for an earnings trade, I like to go back about eight quarters, and look at how the stock performed before, during, and after reporting earnings. Knowing how a stock traditionally reacts is crucial to trading earnings.

Now you can see that majority of the time, Costco (COST) actually traded lower after earnings, but not by that much. For the most part the moves were less than $8 (and on a regular basis less than $5).

Costco

So, for this reason I decided to sell an iron condor, so that I could take advantage of a phenomenon called the IV crush.

What’s the IV Crush?

Basically, what happens is prior to an earnings report, the implied volatility (IV) in the options market gets up to a peak. You can see the implied volatility right here in this screenshot:

the IV Crush

In the screenshot above the implied volatility for Costco was 74.53%.

Now what happens is because the implied volatility is so juiced up, the price of the option is elevated. And the price is elevated because of an event, which in this case is the earnings report, that's going to cause volatility. When the options cost more than normal like this, I like to take advantage of that by selling an iron condor.

But why an iron condor?

I chose an iron condor in this instance because I didn't care if the price went up or down, I just wanted it to stay within a certain range. Now I actually had two iron condors on this ticker, but I want to focus on one in particular...

The 340 Iron Condor:

So, I sold a 340, 325 put credit spread on Costco, and then I also sold a 340, 355 call credit spread. This is the range that Costco needed to stay within.

I was able to sell this for $10.23, which meant that if Costco traded up $10 or down $10, it would break even. However, if it traded in a move less than $10, I’d make money overnight. How? Because I was trading the IV crush phenomenon, so we could expect that that IV was going to be crushed. That meant the price of the option was going to be lower the day after earnings than it was before. And if Costco didn't move within a wide range, we could've made money via premium decay.

So I went ahead and sold that for $10.23 in my Stacked Profits Mastery program. But the especially cool part?

I worked through this whole trade during our monthly live trading session, so all the members could trade along with me and watch it unfold in real-time. I actually ended up trading a couple other trades as well in the Mastery around the same time (another iron condor and some unbalanced butterflies). So, if this particular trade wasn’t your speed, there were others to choose from.

Now for the Profit:

The Profit

I bought back the iron condor at $4.77—that was a little more than 50% overnight. Since it was less than an $8 move, we made money just on the fact that Costco barely moved. While it’s always fun to trade massive moves in the market, I wanted to show this trade as it’s a favorite of mine for trading earnings because it shows that you can profit on barely any move at all.

To learn more about Danielle Shay, visit SimplerTrading.com.

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