The Stealth Bomber Option Trade

11/25/2013 6:00 am EST


Dan Sheridan

Instructor, Sheridan Options Mentoring, Inc.

Option mentor Dan Sheridan shares the details of his favorite pre-earnings option strategy that has always been a consistent winner for him.

SPEAKER 1:  Well, option traders love to trade earnings season and we have some tips for you today from Dan Sheridan who is my guest.  Dan, how do I trade earnings with options?  Give us some ideas.

DAN:  First of all, I’ll give you a clear example and we’re coming into earning season.  This was pretty good right now.  The key is this, where does the earnings trade fit in?  Three parts of the portfolio – I have my nondirectional type trades that I will do by probability type trades for monthly income.  Kind of my retirement account monthly income like covered rights.  Then this other part of the portfolio very budgeted called spec.  That’s the most fun for everybody, right?  Betting on which way the market.  The spec trades I use are based on earnings.  An example would be, what I would tell people is take three stocks that you enjoy looking at.  I take maybe Google, Apple and whole foods; those are three that I’ve watched.  You can’t take all of them.  Take three and you get used to them.  I like, I’ll just give one trade for today.  It’s called the stealth bomber kind of trade.  It’s called the pre-earnings trade.  What I do is I go to Apple or one of the stocks that has earnings after expiration.  Your major cycles are January, April, July and October.  If you take Apple, Apple always has their earnings after expiration week, right?  So does Amazon.  The idea is about two or three weeks before earnings, I go in, and this is one of the best times of the year to do calendars, two to three weeks before so we’re coming before earnings.  What I’ll do is buy an expiration.  Let’s say I’ll make up a price 400/500, let’s say $500.  I’m going to buy at 500 strikes in an expiration that’s going to be effected by earnings so it’s going to keep the option volatility up because you have this event coming.  I’m going to sell at the money call that’s going to be expiring before earnings so I’m selling, Apple is at 500.  I’m selling the 500 calls in an expiration that won’t be effected by earnings.  The idea is nothing big is happening; that’s just going to decay.  Then the option I’m buying since it’s going to be effected by earnings even though I’m paying up a little more, it’s going to continue to rise.  I think it’s one of the best times of the year to do a calendar because it’s the only time during the year that you can almost, have to be careful with this word, almost be guaranteed that you cannot lose money from the volatility going down because you’re buying the event.  I think doing those at the money calendars before earnings, I’m going to take them off before earnings.

SPEAKER 1:  That was my question.

DAN:  I’m going to take them off before earnings.  These are like a 10- or 12-day trade I’m putting on before earnings, taking them off before, and this is a great strategy, kind of a stealth strategy.  I’m out before the action, but the key is my long option is going to stay up because of the event.

SPEAKER 1:   You don’t recommend then holding options through earnings as a directional play.

DAN:  I think that’s a different, that’s a different trade.  What I just described to you I would call monthly income because we’re not going to be there for the event.  If you want to go through the event and put something on a day or two before the event, that’s a total spec part of the portfolio, then you’re just taking a directional play.  I shouldn’t say directional, or you say I think trading earnings is basically saying do you think it’s going to beat expectations or not?  If Apple’s expectations are this based on the last four or five earnings cycles, if expectations are this, all right?  I’m going to put it more of a range-bound trade like an iron condor or calendar that makes money range bond if I think that it’s going to beat expectations.  The last five earnings, the average move is 5%, I think it’s going to move 10%.  I might buy a vertical spread or a put or a call depending on my direction.  I think earnings are a speculative play.  It’s a craft and I think the first thing is for people to start with are one, two or three stocks.  What I described is kind of the stealth bomber pre-earnings calendar.

SPEAKER 1:  Dan, thanks for your time.

DAN:  Thanks a lot, appreciate being here.

SPEAKER 1:  You’re watching the video network.

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