Earnings season is just around the corner. If you think that you can predict the results of the upcoming earnings, you can just buy/sell the stock or calls/puts ahead of earnings. In my opinion, earnings are 50/50. I prefer not to take any directional risk.
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. Next week, two big banks will be reporting their earnings.
The stock is currently trading at $33.65. The stock has weekly options. The suggested trade is:
- Buy WFC April Week2 2012 $33.00 put
- Buy WFC April Week2 2012 $34.00 call
JPM is currently trading at $44.40. The stock has weekly options. The suggested trade is:
- Buy JPM April Week2 2012 $44.00 put
- Buy JPM April Week2 2012 $45.00 call
Due to the high negative theta of the trades, I recommend placing both trades only 1-2 days before the earnings, i.e. Tuesday or Wednesday. You need to exit the trade on Thursday, April 12 before the market close. If we get the IV increase and even moderate movement of the stock, the trade can deliver 25-30% gains. Worst case scenario I don't expect to lose more than 10-15% due to the short holding period.
The main idea behind those trades is "renting the strangle/straddle" before the earnings. An increase in IV should help to neutralize the negative theta and keep the floor under the strangle price. The main and only risk of those trades is the negative theta (time decay). If the stock moves, it should help to increase the gains. In case of those two stocks, I don't expect a dramatic IV increase, so we should hope that the stock moves during our holding period.
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.
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. If you decide to place those trades, please make sure you understand what you are doing.
Additional disclosure: I will be initiating both positions next week