Buying puts or calls just before the numbers come out is a fool's game - Philip Elmer-DeWitt
As I explained in one of my previous articles, buying call or put options on Apple (NASDAQ:AAPL) just before earnings would be a losing proposition. Philip Elmer-DeWitt, a well known writer and editor, agrees:
As near as I can tell, the only people making money in options are the traders who are selling them or simultaneously buying and selling puts and calls in complex combinations.
Jeff Augen, a successful options trader and author of six books, confirms as well:
There are many examples of extraordinary large earnings-related price spikes that are not reflected in pre-announcement prices. Unfortunately, there is no reliable method for predicting such an event. The opposite case is much more common - pre-earnings option prices tend to exaggerate the risk by anticipating the largest possible spike.
Let's check how this strategy would work on another popular stock, Amazon (NASDAQ:AMZN).
The following table presents a one-day return of the ATM (At The Money) call option purchased at the close before the earnings day and sold at the close the next day. If the stock was between strikes, the next OTM (Out of The Money) option was chosen.
(Click charts to expand)
Not so good as we can see. How about the puts?
Maybe buying both (a straddle) will do the trick?
As we can see, Amazon confirms the thesis - this strategy wouldn't work very well for this stock.
Of course there are always exceptions. Google (NASDAQ:GOOG) is one of the them, as I wrote in my article "Should You Buy Google Straddle Ahead Of Earnings?" A GOOG one-day straddle would perform very well, resulting a healthy 35.4% average return. Netflix (NASDAQ:NFLX) is another one - a one-day straddle would return a whopping 44.4% in the last eight cycles.
However, even for those few exceptions, this strategy lacks consistency and predictability. You can get over 100% return in one cycle and lose 50%-70% in the next one. Do you want to take that risk?
So if this strategy doesn't work, which does? My favorite way to play earnings is buying a straddle or a strangle a few days before the announcement to take advantage of the rising IV (Implied Volatility) of the options before the earnings. I will sell just before the numbers are released when the IV has peaked and NOT hold through earnings. I described the general concept in my article "Exploiting Earnings Associated Rising Volatility."
I will describe in one of my next articles how I play Amazon earnings. Stay tuned.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.