The market has been brutal to trade since the first of the year and to make things more interesting, we have now started earnings season. This typically gives us more volatility, but also gives us opportunities to trade the actual earnings releases or to trading around earnings.
There are many things to consider when trading earnings. Which stocks are reporting and when? Do we want to be in these names or out of them…ie… long or short? How is the best way to structure a trade based on your analysis? We also have to consider the overall market and each company’s competitor’s earnings releases and how they may affect the names we are trying to trade. They are many facets to trading around earnings, so I want to narrow down a few things for you.
In looking at option trade set ups, you should consider;
1. What is the MMM (market maker move) projection? In looking at the MMM, this will give you a very good idea of what is “expected”. On most platforms, the MMM can be found on the trade tab and is simply what the market makers are pricing in, as far as an up or down price move. This will give you a starting point to see how far up or down, price-wise, your stock may move. This further gives you an idea of where to place your trade for the actual earnings release.
2. What is the expected move to your expiration? The expected move to expiration is different from the MMM. The expected move is similar with the difference being that the expected move is based on how long your option expiration is. For example, the expected move for an option that expires in 1 week may be $2 and going out further in time, the expected move to the following week may be $5. The longer in time, the more likely for a larger range of movement. Again, the goal here is to give you a point of reference of where to place your trade over your chosen time frame.
3. What is the overall market doing? Is the overall market in a strong bull market trend or in a strong bear market trend? It can make a difference in how your earnings trade may perform.
4. What have the last 3-4 quarters of earnings been like? I always like to look back at the last 3 or 4 quarter and see if a company is constantly beating estimates or constantly missing estimates.
5. What is the best strategy to use? This is where the rubber hits the road. Once you have completed all of your homework on the stock, you need to choose a strategy. In the big picture, you should use a trade that is a negative Vega trade. That is one that will take advantage of the volatility crush that is inevitable. These type trades are Credit Spreads, Iron Condors, Iron Butterflys, and Regular Butterlys. The best earnings trade are NOT Calendars and Diagonals and typically not Long Calls or Long Puts. I will always run different scenarios for different strategies to see which gives the best risk / reward and then choose the best strategy.
Sounds easy, right? Once you go through these simple steps to get the right trade strategy and put the trade in the right location price-wise, the rest is just hurry up and wait on the earnings announcement.
Want more of Bruce? Check out BIAS (Bruce’s Income Advisory Service).