Next week is one of busiest weeks in this earnings season. A bunch of companies will be reporting earnings, including some of the big names.
My regular readers already know that my favorite way to play earnings 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 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. Apple (NASDAQ:AAPL) is one of the best candidates for this strategy.
In some cases I will buy an Out-of-The-Money (OTM) strangle and sell a further OTM strangle, creating a Reverse Iron Condor. I used this strategy to play FedEx (NYSE:FDX). The trade was very successful, producing a 27% gain in six days. I played Google (NASDAQ:GOOG) earnings in similar way and closed the trade for 14% gain.
So here is the list of the next week candidates in chronological order:
Trade # 1: Harley-Davidson (NYSE:HOG)
Harley-Davidson reports earnings on Tuesday, January 24, 2012, before the market close. With the stock currently around $41.80, I'm looking at the following trade:
Buy HOG February 2012 40.0 puts
Buy HOG February 2012 43.0 calls
Trade # 2: Apple (AAPL)
Sell AAPL January 2012 Week 4 410.0 put
Buy AAPL January 2012 Week 4 415.0 put
Buy AAPL January 2012 Week 4 435.0 call
Sell AAPL January 2012 Week 4 440.0 call
Trade # 3: SanDisk (SNDK)
SanDisk reports earnings on Wednesday, January 25, 2012, after the market close. With the stock currently around $51.20, I'm looking at the following trade:
Buy SNDK January 2012 Week 4 50.0 put
Buy SNDK January 2012 Week 4 52.5 call
Trade # 4: Netflix (NASDAQ:NFLX)
Netflix reports earnings on Wednesday, January 25, 2012, after the market close. With the stock currently around $94.50, I'm looking at the following trade:
Buy NFLX January 2012 Week 4 90.0 put
Buy NFLX January 2012 Week 4 100.0 call
If you want to be less aggressive, you can sell the 85 puts and 105 calls, creating a Reverse Iron Condor, like in Apple's case.
Trade # 5: Juniper Networks (NYSE:JNPR)
Juniper reports earnings on Thursday, January 26, 2012, after the market close. With the stock currently around $22.0, I'm looking at the following trade:
Buy JNPR February 2012 22.0 puts
Buy JNPR February 2012 22.0 calls
Notice that I'm buying the same strikes this time, creating a straddle.
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 main idea behind those trade is "renting the strangle/straddle" (or the reverse Iron Condor) before the earnings. An increase in IV should help to neutralize the negative theta and keep the floor under the strangle price. As we know, earnings are 50/50. This is a trade for those who don't want to bet on the direction of the stock and don't want to hold through earnings.
Some additional considerations for all trades:
The main and only risk of those trades is the negative theta (time decay). Some of the trades are using options which expire in just few days so the theta is fairly large. The expectation is that an increase in IV will offset the theta, but it doesn't always happen. If the stock moves, it will help. In any case, you can control your loss since theta damage is gradual. It very unusual to lose more than 10-15% on those trades.
If you don't want to place the Reverse Iron Condor, you can do the trade with the strangle or straddle. The trade will be more expensive and the negative theta much higher, so I recommend to be in the trade no more than 3-5 days.
Choice of strikes depends on your risk tolerance. Risk and reward are always closely related. Going far out of the money will gain more if the stock has a decent move. Going near the money will gain less with less risk. I usually like strikes with deltas in the 25-30 range, which is a good compromise in my opinion. My article "Google Earnings Trade: Risk Vs. Reward" has a good discussion on the choice of strikes.
Instead of weeklies, you can choose more distant expiration to reduce the effect of the negative theta. However, the IV increase for the distant expiration will be less as well. The IV is the most inflated for the options with closest expiration.
Good luck. Let me know if you have any questions in comments below.
Disclosure: I have no positions in any stocks mentioned, but I will be initiating some of the mentioned trades in the next 72 hours.