I did a very short study on this. This play has been a consistent winner with an 89% win rate. There are a few straddles mixed in and I will post that similar strategy later.
Keep in mind that if there is a blowout of one of my strikes, one bad trade can wipe out all my earnings. This happened with FedEx. It ate my breakfast and didn’t even leave me any crumbs. I woulda, coulda, shoulda added wings and turned it into an iron condor in order to limit my loss. This was an expensive learning investment.
Directional Assumption:
Based on past earnings day underlying price.
A short strangle gives me the obligation to buy the stock at the put strike price and the obligation to sell the stock at the call strike price if the options are assigned. I am wanting the stock price to remain somewhere between the put and call strike so the the options I sell will expire worthless.
When to Run It
1 Day Prior to the earnings announcement. Preferably around 3:30 pm to attempt to catch a higher premium due to higher volatility typically at this time and potential volatility crush the next morning at the open.
Setup
- Open the trade on the nearest weekly or monthly option chain. It must be liquid to where there is ideally 500 or more contracts open.
- If the nearest weekly is not liquid enough then trade the nearest monthly.
- Set the spread based on an estimate of past stock movement for earnings. See photo.
- – Sell 1 OTM Call
- – Sell 1 OTM Put
NOTE: Both options have the same expiration month.
Timeline
1 day prior to Earnings
Ideal Implied Volatility
** 30% or greater**
Implied volatility (IV) plays a huge role in my strike selection with strangles. The higher the IV, the wider my strangle can be while still collecting similar credit to a strangle with closer strikes that are sold in a lower IV environment.
If I choose to keep my strikes closer to the stock price, a higher IV environment will yield a much larger credit, but with less probability as IV is essentially a reflection of the option prices.
Profit Target
Close this trade out as soon as the the market opens. I am taking advantage of potential Implied Volatility crush.
Do not hold this expecting it to go in your favor. If you have to take a loss take it.
Time Decay
Sometimes earnings is on a friday and it is a weekly option. If the underlying price does not blow out your spread theta decay is accelerated.
Maximum Profit
Potential profit is limited to the net credit received.
Maximum Loss
This is an undefined risk trade since the call and put I am selling are naked. It also takes up more buying power because of the risk.
If the stock goes up, my losses could be theoretically unlimited.
If the stock goes down, my losses may be substantial but limited to the put strike minus the net credit received.
Risk Management
This trade can be 1% of my account.
Tip
Set my strikes to what I think the underlying price will move based on past earnings dates. Again, see the photo.
Do not hold this trade. Close it out as soon as the market open in order to take advantage of volatility.
I can skew the trade to either a bullish or bearish direction by simply adjusting the strike prices up or down to where I think the stock will trade.
If this is a stock that is extremely volatile and could blow past my strikes, either don’t trade it or buy wings to turn it into an iron condor in order to limit any potential losses. The trade off is less premium.