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In this article, I will describe some of my favourite ways to trade earnings for companies reporting during the week of Jan.30-Feb. 4, 2012.

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 (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.

In some cases I will buy an Out-of-The-Money (OTM) strangle and sell a further OTM strangle, creating a Reverse Iron Condor.

So here is the list of next week's candidates in chronological order:

Trade # 1: Archer Daniels Midland Company (ADM)

Archer Daniels Midland reports earnings on Tuesday, January 31, 2012, before the market close. With the stock currently around $30.0, I'm looking at the following trade:

  • Buy ADM February 2012 30.0 puts
  • Buy ADM February 2012 30.0 calls

Notice that I'm buying the same strikes this time, creating a straddle.

Trade # 2: Amazon (AMZN)

Amazon reports earnings on Tuesday, January 31, 2012, after the market close.

With the stock currently around $185.10, I'm looking at the following trade:

  • Sell AMZN February 2012 Week 1 175.0 put
  • Buy AMZN February 2012 Week 1 180.0 put
  • Buy AMZN February 2012 Week 1 190.0 call
  • Sell AMZN February 2012 Week 1 195.0 call

Trade # 3: Green Mountain Coffee Roasters (GMCR)

Green Mountain Coffee Roasters reports earnings on Wednesday, February 1, 2012, after the market close.

With the stock currently around $50.20, I'm looking at the following trade:

  • Buy GMCR February 2012 Week 1 50.0 put
  • Buy GMCR February 2012 Week 1 50.0 call

Notice that I'm buying the same strikes this time, creating a straddle.

Trade # 4: Chipotle Mexican Grill (CMG)

Chipotle Mexican Grill reports earnings on Wednesday, February 1, 2012, after the market close.

With the stock currently around $361.00, I'm looking at the following trade:

  • Sell CMG February 2012 340.0 put
  • Buy CMG February 2012 345.0 put
  • Buy CMG February 2012 375.0 call
  • Sell CMG February 2012 380.0 call

Trade # 5: MasterCard (MA)

MasterCard reports earnings on Thursday, February 2, 2012, before the market open. With the stock currently around $342.50, I'm looking at the following trade:

  • Sell MA February 2012 Week 1 330.0 put
  • Buy MA February 2012 Week 1 335.0 put
  • Buy MA February 2012 Week 1 350.0 call
  • Sell MA February 2012 Week 1 355.0 call

The main idea behind those trades 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:

  1. The main and only risk of those trades is the negative theta (time decay). Some of the trades are using options that 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 is very unusual to lose more than 10-15% on those trades.
  2. 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.
  3. 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.
  4. Instead of weeklies, you can choose a 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. The prices might be different when you place the trade so adjust the strikes accordingly.

Disclosure: I will be initiating some of the trades within the next 72 hours

Source: 5 Volatile Stocks For Earnings Trades