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In this article, I will describe some of my favorite ways to trade earnings for companies reporting during the week of February 27-29, 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.

The strategy performed well so far in February, producing an average gain of ~10%. I'm not looking for home-runs here (although I had few when IV spiked), but consistent 10-15% gains with relatively low risk. You can see the YTD performance here. Allocating 10% per trade would produce a 15% gain on the overall portfolio in less than two months with very low risk.

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

Trade # 1: SINA Corporation (SINA)

Sina reports earnings on Monday, February 27, 2012, after the market close. With the stock currently around $64.50, I'm looking at the following trade:

  • Buy SINA March Week1 2012 65.0 puts
  • Buy SINA March Week1 2012 65.0 calls

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

Trade # 2: Priceline (PCLN)

Priceline reports earnings on Monday, February 27, 2012, after the market close. With the stock currently around $590.10, I'm looking at the following trade:

  • Sell PCLN March Week1 2012 575.0 put
  • Buy PCLN March Week1 2012 580.0 put
  • Buy PCLN March Week1 2012 600.0 call
  • Sell PCLN March Week1 2012 605.0 call

I will evaluate the prices when weeklies start trading on Thursday.

Trade # 3: AutoZone (AZO)

AutoZone reports earnings on Tuesday, February 28, 2012, before the market open.

With the stock currently around $359.20, I'm looking at the following trade:

  • Sell AZO March 2012 340.0 put
  • Buy AZO March 2012 350.0 put
  • Buy AZO March 2012 370.0 call
  • Sell AZO March 2012 380.0 call

The current mid price is around $3.60. The spreads are fairly wide, make sure to use limit orders.

Trade # 4: Collective Brands (NYSE:PSS)

Collective Brands reports earnings on Tuesday, February 28, 2012, after the market close.

With the stock currently around $17.40, I'm looking at the following trade:

  • Buy PSS March 2012 17.0 put
  • Buy PSS March 2012 18.0 call

The current mid price is around $1.50.

Trade # 5: Joy Global (JOY)

Joy reports earnings on Wednesday, February 29, 2012, before the market open.

With the stock currently around $90.02, I'm looking at the following trade:

  • Buy JOY March Week1 2012 90.0 put
  • Buy JOY March Week1 2012 90.0 call

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

Trade # 6: Finisar (FNSR)

Finisar reports earnings on Wednesday, February 29, 2012, 2012, after the market close.

With the stock currently around $22.55, I'm looking at the following trade:

  • Buy FNSR March 2012 22.0 put
  • Buy FNSR March 2012 23.0 call

The current mid price is around $2.60.

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 a 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 being 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 have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I have the AZO RIC and may initiate a position in other trades mentioned in the article.