You’ll be hearing a lot more about earnings soon, as companies begin to report first-quarter figures and issue forward guidance.
While a LOT of option players love to trade into an earnings release, personally, I feel it’s a crapshoot.
And crapshoots, as you know, are all about dumb luck.
I don’t trade on luck.
I prefer to take a more skilled and much less risky approach … while still reaping many of the rewards that earnings traders enjoy.
It’s something my Sharp Bets subscribers might see me doing a lot of over the next few weeks …
So today, I’ll show you that when it comes to speculating on earnings, it often pays to lurk in the shadows and not strike until the timing is right.
Paying the Pre-Earnings Premium Tax
Of course, there will always be unknown events that could make or break an otherwise well-timed trade … those “black swans” that no one sees coming, like with Gamestop (Ticker: GME) and other so-called “meme stocks.”
But black swans aside, there are also KNOWN events that can shake up a stock price, and a company’s earnings report is the most common of these.
Because earnings can send the underlying stock price shooting higher or lower, implied volatility (IV) on those options tends to ramp up heading into the event.
And if you don’t already know, higher IV means higher prices for those options.
See, people are willing to bid up option prices ahead of earnings, because no one knows which direction and to what degree the underlying shares will react.
That means an out-of-the-money (OTM) option that would normally seem like a pipe dream could see heightened demand, because you just never know with earnings … that option could move into the money (ITM) on a dramatic enough reaction from the shares.
A lot of times, though, the pre-earnings IV that’s being priced into short-term options ends up much higher than the stock’s actual post-earnings volatility — meaning pre-earnings buyers likely overpaid.
Take Apple (Ticker: AAPL), for instance.
Over the past two years, the average implied move of AAPL heading into an earnings report was bigger than the stock’s average post-earnings move, at 4.26% vs. 2.88%, respectively.
With the exception of earnings in late July and October 2020, AAPL’s reactions haven’t lived up to the IV hype.
AAPL IVs (blue) vs. actual earnings reactions over 2 years
However, I’m not saying you SHOULDN’T trade earnings …
I have found a method that often lets me capitalize on a stock’s earnings swing without paying all the pre-earnings premium tax …
Lurking in the Earnings Shadows
In a nutshell, I love trading UP TO and JUST AFTER earnings.
I’ve found that I can usually trade a post-earnings trend at a much cheaper price than if I’d bought ahead of the event, if I just jump in the day after earnings.
By doing this, I have an advantage in that I already know which way the shares are swinging — and taking the guesswork out of direction is clutch.
I don’t have to pay double premiums for a “directionless” volatility trade like a long straddle, which involves buying both calls and puts, and praying for a big enough move to cover the cost of entry.
I’ve also found that by lurking in the proverbial shadows and waiting to see how the stock reacts, I can get in on the post-earnings volatility crush, and pick up options for a relative bargain.
Sticking with AAPL as our guinea pig, take a look at how much it would’ve cost to buy the 135-strike put option expiring Feb. 5, had I bought on Jan. 27 — just hours before the iPhone maker reported earnings.
I could’ve paid up to $4 for that put (the ask price), which was about $7 out of the money, with AAPL shares trading around $142 at the time.
AAPL Feb. 5 135-strike options on Jan. 27, 2021
However, if I had WAITED until Jan. 28 — the day after earnings, when AAPL shares were swimming in red ink — I could’ve picked up those same put options for $2.90 or less.
AAPL Feb. 5 135-strike options on Jan. 28, 2021
That’s even WITH the option closer to the money, with AAPL trading around $137!
And there was still downside gas in the tank for Apple shares, too. The stock ended up sinking to test the $130 area at its post-earnings lows.
Daily chart of AAPL – courtesy of StockCharts
Therefore, come Jan. 29, I could’ve closed those 135-strike puts — now ITM — for more than $5.50!
AAPL Feb. 5 135-strike options on Jan. 29, 2021
Not a bad return for not having to pick a direction, and a better return than the trader who’d bought those same puts earlier for $4.
So, fellow traders, this earnings season, consider lurking in the shadows … let the move start to happen, and if you feel there’s enough directional juice left on the charts, only THEN set up your trade.
I’ll be doing this a lot in Sharp Bets, so if you’re not already a member, I hope to see your name on the list soon!
Your Only Option,