If you trade options, know the impact that earnings can have on your position.
Intrinsic Value and Time Value
Earnings reports have the potential to cause significant price swings. Indeed, it is not unusual for a significant increase or decrease in a stock price to occur immediately after an earnings report. The US market is just past the midway point of the current earnings season.
If you are considering using options to trade an earnings report, here are some tips and strategies to consider. Make your stock forecast Know your options Trading options involves more risk than buying and selling stock, and only experienced, knowledgeable investors should consider using options to trade an earnings on options are real report. The first step when trading earnings with options is to determine what direction you think the stock could go. This forecast is crucial because it will help you narrow down which options strategies to choose.
For example, if you expect that there will be a positive price move after an earnings report, you could buy call options. Alternatively, if you expect that there will be a negative price move after an earnings report, you could buy put options. Volatility forecast In addition to assessing which direction a stock might go, consider the magnitude of volatility the stock may exhibit around an earnings report. In this regard, volatility can be considered how far a stock price moves from some average.
To see why volatility is so important, check out the chart below which shows day earnings on options are real volatility HV versus implied volatility IV going into an earnings announcement for a particular stock.
Historical volatility is the actual volatility experienced by a security. Implied volatility can be viewed as the market's expectation for future volatility.
Directional Earnings Options Strategy #1: Buying a Call
Consider the Greeks and implied volatility when trading options going into an earnings release Source: Fidelity. Screenshot is for illustrative purposes only. This is intended to show that volatility can have a major impact on the price of the options being traded and, ultimately, your profit or loss.
Essentially, the closer to an earnings report, the greater the potential volatility—and consequently, the more expensive an options contract will be, relative to time periods further away from an earnings report. Options for existing positions Once you've made your stock and volatility forecast, it's time to start thinking about the type of position you believe might capitalize on this forecast.
Is it a net new position or are you managing an existing position? If you are already in a stock that is expected to report earnings in the near future, you can use options to hedge, or reduce exposure to, existing positions before an earnings announcement.
For instance, if you are in a short-term long stock position e. This is because if the stock were to decline in value, the put option would likely increase in value. Advanced options strategies If you are considering a new options position in advance of an earnings announcement, the simplest way to trade it is by purchasing calls if you think the price is going to increase above the current price, or to purchase puts if you think the price is going to decrease below the current price.
In addition to buying calls and puts, there are several multi-leg advanced strategies that can be constructed to trade earnings, including straddles, strangles, and spreads. With a long straddle, you buy both a call and a put option for the same underlying stock, with the same strike price and expiration date.
What are realistic returns for options income trading?
If the underlying stock makes a significant move in either direction before the expiration date, you can make a profit. However, if the stock is flat, you may lose all or part of the initial investment. To construct a long straddle, you might buy 1 You would earn a profit if the stock moves above how to make money make money in below these breakeven prices after the earnings announcement.
Long straddle example Source: Fidelity. However, options prices with high volatility tend to be more expensive and can impact the potential profitability.
A Few Options Strategies to Consider Earnings season can be a time of higher-than-typical volatility, which can mean an increase in risk as well as opportunity. Learn some of the options trading strategies you might use during earnings season. Implied volatility IV may also rise to unusually high levels in the days or weeks leading up to an earnings release. Many option traders view price movement as a potential opportunity.
If a fall in implied volatility impacts the options price more than the move in the price of the underlying security, the option strategy may become unprofitable after the announcement, even if the stock moves significantly.
All of the same can be said for a similar options strategy known as the strangle. Strangles—Like the long straddle, a long strangle is an options strategy that enables a trader to profit if there is a big price move for the underlying stock.
The primary difference between a strangle and a straddle is that a straddle will typically have the same call and put exercise price, whereas a strangle will have 2 different exercise prices. Long strangle example Spreads—A spread is a strategy that can be used to profit from volatility in an underlying stock. Different types of spreads include the bull call, bear call, bull put, and bear put.
Call credit spread example Source: Fidelity. Put credit spread example Source: Fidelity. Finding opportunities Information about when companies are going to report their earnings is readily available to the public.
Options and earnings
More in-depth research is required to form an opinion about how those earnings will be perceived by the market. Of course, traders can be exposed to significant risks if they are wrong about their expectations.
The risk of a larger-than-normal loss is significant because of the potential for large price swings after an earnings announcement.
Options can magnify those losses. Any strategy should be considered within the context of your individual investing or trading plan. If you know the types of strategies that are available, you can choose the right one for your investing and trading goals. A company's earnings report is a crucial time of year for investors.
Expectations can change or be earnings on options are real, and the market may react in various ways. If you are looking to trade earnings, do your research and know what options are at your disposal. Next steps to consider.