I described here how I play earnings with strangles. As a reminder, the method involves buying a strangle few days before earnings and selling it just before earnings are announced (or before if the trade produces a profit).
But what if you look at a specific stock and find out that the cost of the strangle is too expensive? AutoZone (NYSE:AZO) is scheduled to report earnings on December 6. With the stock trading around $330, you look at a 320/340 strangle and find out that it will cost you almost $900 to place the trade. There is a way to reduce this cost. You can sell another strangle which is further OTM (Out of The Money). Here is the trade:
- Sell AZO December 310 put at $2.57
- Buy AZO December 320 put at $4.73
- Buy AZO December 340 call at $3.63
- Sell AZO December 350 call at $1.59
The total cost for this trade is $4.20 per spread, about half of the cost of the strangle. The official name of this strategy is short Iron Condor.
If the stock moves 10 points up or down, just move the strikes the same direction.
For this trade to make money, one of the two things have to happen:
- Stock has to move before earnings.
- IV (Implied Volatility) of the options has to increase to make the options more expensive.
If one or both of those things happen, the trade has a good chance to make 25-30%. If both the stock and the IV remain unchanged, the trade will lose money due to negative theta. Currently the negative theta is 1.7% per day, so if you hold the trade five days and nothing else is changed, you can lose around 8-10%. However, there is a very good chance that the IV will increase before earnings. If the stock moves as well, it will increase the profitability of the trade.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I currently own the AZO short Iron Condor.