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Another quarterly earnings announcement season is approaching fast. There are many way to play earnings. Some traders like to buy calls or puts and bet on the direction of the post-earnings move. My favourite way is buying a strangle a few days before earnings and selling it just before earnings are announced (or as soon as the trade produces a sufficient profit). The idea is to take advantage of the rising IV (Implied Volatility) of the options before the earnings. (I described the general concept here.)

In general, I look for companies having a history of big post-earnings price moves. Those big moves will cause the IV to spike before earnings. The first month of the earnings season presents some of the best opportunities for this strategy. The list of the best candidates includes the following stocks:

  • Apple (NASDAQ:AAPL)
  • Google (NASDAQ:GOOG)
  • Netflix (NASDAQ:NFLX)
  • F5 Networks (NASDAQ:FFIV)
  • Amazon (NASDAQ:AMZN)
  • First Solar (NASDAQ:FSLR)
  • Akamai Technologies (NASDAQ:AKAM)
  • Intuitive Surgical (NASDAQ:ISRG)
  • Wynn Resorts (NASDAQ:WYNN)
  • Baidu (NASDAQ:BIDU)
  • Cree Inc. (NASDAQ:CREE)
  • Goldman Sachs (NYSE:GS)
  • Harley-Davidson (NYSE:HOG)
  • Juniper Networks (NYSE:JNPR)
  • SanDisk (NASDAQ:SNDK)

All of these report in January. Next week there are three companies matching the criteria. I will describe the historical earnings price moves, the IV history and the suggested trades.

Trade 1: The Mosaic Company (NYSE:MOS)

Mosaic reports on January 4, 2012, after the market close. Here is the history of the last four post-earnings moves:

Here is the MOS Volatility chart:

I circled the area of the previous earnings. As we can see, the IV spiked about 25-30% before the previous earnings release. Currently the IV is still well below the previous pre-earnings levels.

MOS is currently trading at $49.75. The stock has weekly options. The trade I’m looking at is:

  • Buy January 2012 Week1 50.0 puts
  • Buy January 2012 Week1 50.0 calls

As of this writing, the trade can be done for about $3.00.

Please note that I’m buying a straddle here, not a strangle (the puts and the calls are the same strike). The reason is to reduce the negative delta since those are weekly options. The negative theta of the trade is currently about 6.1%. That means that, all other factors equal, the trade will be losing 6.1% per day. This is a fairly large theta, so we need to be in this trade only for 1-3 days. The rising IV should offset the negative theta at least partially.

Trade 2: Monsanto (NYSE:MON)

Monsanto reports on January 5, 2012, before the market open. Here is the history of the last four post-earnings moves:

Here is the MON Volatility chart:

I circled the area of the previous earnings. As we can see, the IV spiked about 10% before the previous earnings release. Currently the IV is still well below the previous pre-earnings levels.

MON is currently trading at $70.20. The trade I’m looking at is:

  • Buy January 2012 67.5 puts
  • Buy January 2012 72.5 calls

As of this writing, the trade can be done for about $2.20.

The negative theta of the trade is currently about 3.8%. That means that, all other factors equal, the trade will be losing 3.8% per day. So, worst-case scenario, the trade might lose around 15%-17% before the earnings. However, the rising IV should offset the negative theta.

Trade 3: Apollo Group (NASDAQ:APOL)

Apollo reports on January 4, 2012, after the market close. Here is the history of the last four post-earnings moves:

Here is the APOL Volatility chart:

I circled the area of the previous earnings. As we can see, the IV spiked about 50% before the previous earnings release. Currently the IV is still well below the previous pre-earnings levels.

APOL is currently trading at $53.50. The trade I’m looking at is:

  • Buy January 2012 50.0 puts
  • Buy January 2012 55.0 calls

As of this writing, the trade can be done for about $2.85.

The negative theta of the trade is currently about 3.5%. That means that, all other factors equal, the trade will be losing 3.5% per day. So worst-case scenario, the trade might lose around 12%-15% before the earnings.

For all trades, the rising IV should offset the negative theta. If the stock moves, it should help to increase the gains. My plan is to take the profits and roll to new strikes if the stock makes a decent move. And don’t forget to sell before earnings.

The MOS trade is the most risky, since we are trading the weekly options and the negative theta is fairly large. I suggest using a 30% stop-loss. I will update in the comments when I get in for each trade and at what price.

Disclosure: I have no current positions in any stocks mentioned. I will be opening the MON, MOS and APOL strangles in the next 48 hours.

Source: Trading The Pre-Earnings Volatility Spike On Monsanto, Mosaic And Apollo