Option Strategies For Earnings Season

11/11/2013 6:00 am EST

Focus: OPTIONS

Dan Keegan

Founder, Optionthinker.com

The Chicago School of Trading's Dan Keegan discusses some of the various option strategies than can be most profitable during earnings season.

SPEAKER 1:  While traders love earning seasons, there's usually a lot of volatility and a lot of ways to make money with that, but how do you do that and especially how do you do it with options?  My guest today is Dan Keegan to talk about that, so Dan, earnings is always a great time to trade, because a lot of things are moving, a lot of news.  What are you recommendations here in terms of using options overall to profit from that?

DAN:  I think one strategy you can use during earnings season is if people are expecting a big move in an issue, that means they're going to be running in, buying the puts and calls, and the price level and the premiums going to go really high in that first month, and so what you might want to do is you could buy this next month out premium and then, for instance, let's say in Google, if it happens to be - who knows where it'll be at earnings day, but if it's at 850 and the current term with two days left, the "at the money" call might be as high as $20 and you could buy the next month out for $25, so you're buying a $5 time spread where you're selling the front month for $20.  Now, if it makes a dramatic move in either direction, it's a loser, but you have a defined loss, and if it doesn't make a dramatic move, which occasionally Google does not, and other big movers like that, you could see that time spread more than doubling, maybe even going to two and a half times its value.

SPEAKER 1:  One of the things about earnings that I think trades have a tough time with is they expect good earnings to result in a higher stock price and for whatever the stock price just tanks.  I mean, how could you use options to profit either way, so that if I know it's going to move, I just don't know which direction that I can still be okay and make some money there.

DAN:  Well, one thing you'd do is you could buy a straddle.  The problem is with earnings it gets pumped up, the premium gets pumped up, so that's a tough strategy to do, but what you can do is some of them, the straddle isn't as pricy as it normally is.  You take a look at that and maybe look at the previous six or seven earnings, see where their money straddle is trading.  If it's smaller than it normally is, you might want to take a shot at that.

SPEAKER 1:  If they're pricey, does that necessarily mean maybe I should be a seller of options around earnings time?

DAN:  It is, and actually, the time spread is an excellent way of doing that.  Where as if they're just - the implied volatility might be double for the month that's expiring soon versus the next one out, so you just want to see - you're not so much guessing what's going to happen, if there's going to be a big move or a small move, but what you're doing is you're saying okay, this is what the market is giving me, my volatility is so high compared to the other one, I've got to try it.

SPEAKER 1:  Should I be looking historically at how a stock moves in their earnings?  I mean, we want a lot of movement, right, theoretically.

DAN:  Depending on what you do, like, if you're aligning a time spread, you would like to see no movement and then you'd have a big move, but yeah, basically what you want to do, and then if you see the straddle is trading at a really low level, but then you see three out of the last four times it's gone way higher than that, you might take a shot at that.

SPEAKER 1:  Dan, thanks for your time.

DAN:  Thank you.

SPEAKER 1:  You're watching the MoneyShow.com Video Network.

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