Earnings Season Tactics: Strategies for Finding Profitable Options Trades

Earnings season is here and we’ve already seen some big name companies report earnings including Citigroup (C), JP Morgan Chase (JPM), Delta Airlines (DAL), Wells Fargo (WFC) and Blackrock (BLK).
 

This week we have Bank of America (BAC), Johnson & Johnson (JNJ), UnitedHealth Group (UNH) and Netflix (NFLX).

In today’s article, we will look at how to use Barchart’s Screener’s to find option trade ideas for this earnings seasons.

Stock Screener

The first step is to use the Stock Screener to find companies with good option volume and upcoming earnings. Here’s a good scan that you might like to use:

• Total Call Volume greater than 2,000
• Market Cap greater than 40 billion
• Latest Earnings Date Between April 16 - 19

This will give us companies with earnings releases this week that have good option volume. Trading stocks with good option volume is important because it will mean it is easier to get filled on trades and the bid-ask spread is likely to be lower.

The above screener gives us these results:

Now we can pick the company or companies we want to trade and decide on a strategy. Let’s look at a couple of examples.

UNH Iron Condor

An iron condor aims to profit from a drop in implied volatility, with the stock staying within an expected range.

When implied volatility is high, the wider the expected range becomes.

The maximum profit for an iron condor is limited to the premium received while the maximum potential loss is also capped. To calculate the maximum loss, take the difference in the strike prices of the long and short options, and subtract the premium received.

As a reminder, an iron condor is a combination of a bull put spread and a bear call spread.

First, we take the bull put spread. Using the April 19 expiry, we could sell the $415 put and buy the $410 put. That spread could be sold yesterday for around $0.60.

Then the bear call spread, which could be placed by selling the $475 call and buying the $480 call. This spread could also be sold yesterday for around $0.70.

In total, the iron condor will generate around $1.30 per contract or $130 of premium.

The profit zone ranges between $413.70 and $476.30. This can be calculated by taking the short strikes and adding or subtracting the premium received.

As both spreads are $5 wide, the maximum risk in the trade is 5 – 1.30 x 100 = $370.

Therefore, if we take the premium ($130) divided by the maximum risk ($370), this iron condor trade has the potential to return 35%.

If price action stabilizes, then iron condors will work well. However, if UNH stock makes a bigger than expected move, the trade will suffer losses.

Trades held over earnings allow little room for adjusting, so they can be a bit hit or miss. UNH has stayed within the expected range following three of the six most recent earnings releases. Although as we know, past performance doesn’t guarantee future performance.

Traders can also use the Bull Put Spread Screener if they have a bullish outlook or the Bear Call Spread Screener if they have a bearish outlook.

NFLX Diagonal Put Spread

For NFLX, we could look at selling an April 19 put with a strike price of $545 and buying a May 3 put with a strike price of $535.

The April 19 put could be sold for around $5.00 and the May 3 put could be bought for $6.30.

The trade would result in a net debit of $130 which is also the maximum risk on the upside. 

The risk on the trade is on the downside with a potential maximum loss of $1,130. This is calculated by taking the difference in the spread (10) multiplied by 100 and adding the premium paid (130).

The maximum potential gain is around $1,800 which would occur if NFLX closes right at $545 on April 19.

The trade has a nice profit zone in between $505 and $650.

Aiming for a return of around 10-15% makes sense and I would set a similar stop loss.

The worst-case scenario is a sharp drop in NFLX stock early in the trade. For this reason, if the stock drops below $545 in the next few days, I would also consider closing the trade early to minimize losses.

The initial trade set up has a delta of -1 meaning the position is roughly delta neutral to start. Note that this delta number can change significantly as the stock starts to move.

If the stock is getting close to $545, it may be wise to close the trade before the earnings announcement.

Conclusion And Risk Management

Trading options over earnings can be risky and is not recommended for beginners. Short-term trades over earnings such as these ones are almost impossible to adjust. Either the trade works, or it doesn’t so position sizing is vital. Short strangles involve naked options and should be avoided by beginner traders.

Short-term trades also have assignment risk, so traders need to be aware of that possibility.

Please remember that options are risky, and investors can lose 100% of their investment. 

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.