Options In Earnings Season

03/05/2013 1:00 pm EST

Focus: OPTIONS

Steven Place

Founder, InvestingWithOptions.com

There are several specific types of price behavior that options go through during earnings season and Steven Place shares his insights.

My guest today is Steve Place.  We're talking about trading options into earnings and how that works.  So, Steve, what's a good way to kind of get your feet wet trading earnings plays with options?

Okay.  What happens with stocks around earnings is that you have these big, fast, wild moves.  You have the gaps up and everything like that.  The options market starts to price those in as we head into earnings, okay, so, there are ways to profit with options not necessarily playing the earnings event, but speculating that volatility, at least in the options pricing, will continue to rise as we head into the earnings event. 

So, what strike price are we looking at, and how far away, and what's the way to kind of get a feel for that?

There's a lot of what I call "black magic" going on there.  You also have to have price targets.  I'm a big fan of using technical analysis to say, you know, get a directional bias and then look to sort of get a long volatility strategy along with, you know, the direction you're trying to play.

And am I holding these through earnings, or is this something where I'll do it right before earnings and get rid of it so I'm out?

Yes.  This is a specific set of strategies where you would want to be long volatility up until the earnings event and then you close it out, because what happens after earnings is the big move that was priced into the options is now gone.  The short-term risk is now gone, and so there is what's known as a volatility crush in the options market, and that can affect your long vega, okay, your long volatility positions.

Okay, and in terms of size. is there a way that you kind of calculate how much you should be putting on around these plays?

These kinds of trades, if you're going to be speculating into an earnings run-up you generally want to have limited risk play, so I'm looking, you know, normally to lose no more than maybe 1%, 1.5% of a trading account when putting these kinds of strategies on.

How about the overreaction on these earnings plays that often happens; is that a good time to buy or sell calls right after?

It's very difficult to really do that.  It does require a lot of experience.  There are times in which it fades significantly, or there are times when the momentum really picks up, so what you can do is after the earnings event, if you get a big gap, everyone's going to have to chase to close their positions or add those positions on or, you know, adjust their positions against the risk.  So, you can get long volatility through straddles or strangles, because the implied volatility crush gets out of the market, the pricing continues to go down, and then you pick up those straddles and then if the market fades that move really hard or if it continues in the direction of the momentum, then you can profit from that.

So trading options around earnings; an advanced strategy or can anybody really try this?

It's a pretty advanced strategy.  You know, I would focus more on the simple directional plays, maybe focusing on indexes first and then once you learn how implied volatility and how options trade around these events, then you can start, you know, putting a little risk on the table there.

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