Trading Earnings with Options

People working at a trading desk.

Earnings season started this week with a bang, with JPMorgan (JPM) and Citigroup (C) announcing positive results that sent the market trading higher. Next, came a few transportation stocks and the first of the major components of the Nasdaq-100 (NDX) -- Netflix (NFLX).

Knowledge of corporate earnings, and what to do during this time frame, is critical for traders for a few reasons.

  • Earnings give companies the opportunity to put on display their growth. They can show this quarter over quarter, and year over year, along with discussing their forward projections via their guidance. This provides traders with fundamental data that we can use to stock pick, or select tickers we want to trade options on. For me, I love to trade options on strong fundamental and technical names, along with adding them to my stock portfolio.
  • Earnings are a catalyst that impact the direction and movement of the overall stock market and can cause serious volatility. Announcements can be quite significant, causing major surprises to the upside -- or the downside. This can cause some significant price movement. This is especially true when it comes to large cap, heavily weighted stocks. The FAANG’s in particular, move the market, and traders have to be aware of when these reports are happening. This helps traders to know to either trade them, or stay out of their way. The same goes for top weighted products such as Costco (COST) within the Consumer Staples sector (XLP), or Johnson and Johnson (JNJ) and UnitedHeath Group (UNH) within the healthcare sector, (XLV). As an options trader, it’s not a great idea to be heavily long healthcare when JNJ is reporting that day. Or at least, if you are, hope it goes in the direction you want!
  • Earnings provides a trading opportunity in the options world. If you know me, you know I love to trade direction in the stock market. I rarely trade sideways movement. I like to trade earnings in three separate ways. I trade the momentum higher going into a report (the Run into Earnings), the actual report (I just call these earnings trades), and then price movement after the report (2x moves).

Let’s dive deeper and talk about the second one -- trading the actual report.

Let me first start off by saying that trading an earnings report is pretty aggressive, as it is a binary event. However, I still combine my fundamentals, technicals and statistics, and use low risk options strategies, and utilize a small portion of my portfolio to do so.

For an earnings trade, I start with the current stock price, and I place my trades directly before the report. This is typically around market close. I then combine the following factors:

  1. MMM (Market maker expected move): I want to know what move is expected for this ticker.
  2. Past Earnings Moves: I look at the past 8 quarters and see, on average, how much the ticker has moved on earnings and in what direction. If the ticker has a high probability of moving one direction or another, that is the one I stick with. If it is split, both up and down, as long as it is within a similar range, I will trade it neutral.
  3. Support and resistance: I overlay the MMM and past moves with key support and resistance levels. This is usually a combination of Fibonacci, moving averages, and the Voodoo lines (based off of Elliott Wave).
  4. Key Psychological Values: If this overlap is near a nice, round number -- even better. That will be my target price.

Once I have the range I am targeting, based off of the above analysis, I trade this projected move in the options market via cheap butterflies.

NFLX Earnings -- A Case Study

A chart displaying Netflix's stock activity

The day before NFLX earnings, I bought a long call butterfly for $0.83. This is incredibly cheap for an options trade, at less than $100 per contract. I like these ‘lotto’ type flies for earnings, because it is a binary event. For normal trades, I use butterflies that are more expensive, upwards of $5.00.

In this example, I did not have great Fibonacci levels, but I had prior resistance and a potential pinning strike for options expiration. On monthly options expiration Friday, typically we see large cap names getting stuck and closing (pinning) at a key psychological value. The expected move overlaid with $300, as did the previous moves, and the 300 strike also had high open interest and volume. I was expecting an upside move in NFLX because it has gotten beaten down so badly, and it was a case of, “Anything not terrible will probably be good!” Therefore, I picked an upside butterfly with $300 as my target.

Netflix Options Chain with text highlighting notable items

NFLX options chain.

I got the 290/300/310 call butterfly expiring within 2 days. When I paid for it, it was out of the money, which is why it was so cheap. Plus, with only two days until expiration, it also allowed me to get a cheap price.

NFLX surprised on earnings, traded higher after hours, but then came back down to settle around $300. This is where I began scaling out of the trade. Typically, when a ticker trades within the expected move, I look for it to come back where it came from. In this instance, since we also have options expiration this Friday, I was especially looking for a pin. I ended up closing the first half of the position at $2.99, and the second half is trading at $3.70. Not bad for a butterfly that cost $0.83!

This one worked out great -- but of course, there are trades that do not work as well. The key here is to study the ones that work perfectly, along with the ones that do not, to continually hone your trading strategy. As for me, this is my ‘lotto fly’ earnings strategy, and I will be using it frequently this quarter for earnings.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Danielle Shay

Danielle Shay is a market analyst, trader, and expert commentator. She is director of options at Simpler Trading where she runs analysis in the trading room, teaches classes and webinars, and writes on a weekly basis. Her primary focus is on trend-following, directional strategies via options trading, though she trades stocks and ETFs as well. You can also find Danielle regularly in the media, as she is an expert guest on Fox News, Nasdaq TradeTalks, Fox Business, RT America, Yahoo Finance, Cheddar, StockCharts.com, and more. 

As a former teacher, her goal is to help traders grasp the basics that make trading simpler—no matter their skill level. You can find her story and key focus of analysis in her contributing chapters in John Carter's 3rd Edition of Mastering the Trade. Her motto is, "If I can do it, you can do it!"

You can find her daily in the options room at Simpler Trading, at her free newsletter at www.FiveStarTrader.com, on her social media channels, and in the classes she teaches several times per year.

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