Trading The Earnings Announcements  - Before And After

by: Mitch Bulajic

Summary

Trading the earnings announcements before and after the event utilizing options and option spreads is an alternative trading approach that can be very rewarding with a favorable risk/reward profile.

Option strategies are generally grouped by timing (before and after the earnings announcement), volatility positioning (long and short) and market direction bias (neutral, bullish, bearish).

There is an array of stocks with earnings announcements this week that are generating bullish, bearish, and neutral signals.

Bullish AA Iron Condor and neutral AXP Strangle are this week's best all-round trades.

Overview

Company earnings announcements and analyst statements (rating, upgrade/downgrade, color, etc.) are the biggest and, on a regular basis, stock-moving events. Let's take a quick review of both of these events and outline possible methods and strategies for trading these events by positioning before and after the earnings announcements.

Before-Earnings Announcements Market Neutral Short Volatility Strategy

Positioning and trading before and exclusively for the earnings announcements is by all measures a hit or miss high risk/high reward event in a very volatile and crowded field with an array of day traders, speculative option traders, long-short traders, event traders, etc.

Typical strategies are market directional buying or short selling stocks, or market neutral short volatility option strategies selling: out-of-the-money condors, at-the-money iron butterflies, or strangles. The option strategies are more superior, because they minimize the uncertainty of market risk and maximizes the reward of almost certain implied volatility collapse.

Trading Strategies

  1. Iron Condor
  2. Iron Butterfly
  3. Strangle

Trading Conditions and Structure

  • Volatility - Relative implied volatility > 50% of the yearly range, and predictable see-saw implied volatility pattern building-up consistently towards the earnings announcement and then collapsing. (This is not a mandatory requirement, and rare with large cap stocks and in bearish market environment).
  • Liquidity - Average daily stock volume (>100,000), traded option daily volume (>1,000), and option bid-ask spreads (=<$0.10) - or stocks with weekly options expiration, which by default assumes liquidity.
  • Events - No other stock-specific events (M&A, judgements, etc.) and significant market-specific events (employment numbers, CPI, etc.) shortly before or after the earnings announcement.
  • Strike Price - Short options out of the money strike prices with delta between 30% and 15%, for Iron Condors long options (wings) strike prices with delta between 20% and 10%.
  • Trade Entry and Exit - Entry on the close of the day before or on the day of the earnings announcement, and exit right after the earnings announcement.
  • Expiration - First expiration after the earnings announcement date.

Before-Earnings Announcements Market Directional Short Volatility Strategy

Market neutral short volatility strategy can also be tweaked to a bullish or bearish market bias should a trader have a bullish or bearish view of the stock related directly or indirectly to the earnings announcement, making it a market directional short volatility strategy. This is accomplished by taking in more risk and premium on the opposite side of the predicted price direction or by initiating a one-sided trade with all the risk and premium on the opposite side of the predicted price direction.

Our strategy for short-listing stocks with potential directional bias before the earnings announcement is based around money-flows (speculative and institutional) and sentiment (put/call ratio trends and reversals), that are the most reliable gauge of market bias and sentiment of the institutional investors and corporate insiders. Technical patterns and levels are used to confirm the directional market bias and determine price ranges and targets. The trades are typically initiated from one day to one week before the earnings announcement and can last anywhere from the day of the earnings announcement to several weeks thereafter. The desired outcome is profit from market direction, directly or indirectly related to the earning announcement, and collapse of implied volatility.

Trading Strategies

  1. Bullish Vertical Put spreads and Bearish Vertical Call spreads
  2. Bullish and Bearish tilted Strangles
  3. Bullish and Bearish tilted Iron Condors

Trading Conditions and Structure

  • Volatility - Relative implied volatility > 50% of the yearly range.
  • Liquidity - Average stock volume >100,000, option traded volume >1,000, and option traded bid-ask spreads =<$0.10 - or stocks with weekly options expiration which by default assumes liquidity.
  • Events - No other stock-specific events (M&A, judgements, etc.) and significant market-specific events (employment numbers, CPI, etc.) shortly before or after the earnings announcement.
  • Strike Price - Varies to the directional bias trading strategy.
  • Trade Entry and Exit - Entry on the close up to one week before the earnings announcement, and exit on the close up to several weeks after the earnings announcement.
  • Expiration - First or second expiration after the earnings announcement date (depending on the trade specific trade duration analysis and expectations).

Case Studies

AXP Bullish Vertical Put Spread - After-Earnings Announcement

After a very bullish earnings announcement on 4/16 AXP gap opened to upside confirming a positive money-flow/price trend that generated a buy signal triggered on 5/3 at closing price 97.14 and options spread debit 1.47, exit signal was triggered on 5/10 with closing price at 101.27 and options spread debit 2.46 - 0.99 profit (top option spreadsheet, left chart below).

JNJ Iron Condor - Before-Earnings Announcement

Neutral money-flows, range to negative technicals, and slightly bullish put/call ratio spread were indicating a probable neutral earnings announcement and price scenario. This is a standard earnings announcement related market neutral short volatility situation, calling for selling an iron condor right before the earnings announcement on 4/16 at closing price 131.28 and credit 1.65, covering right after the earnings announcement on 4/17 at closing price 128.81 and credit 0.35 - profit 1.30 (bottom option spreadsheet, right chart below).

Courtesy of TD Ameritrade ThinkorSwim

After-Earnings Announcement Market Directional Long Volatility Strategy

Trading the after-earnings announcement and analyst statements that follow is a lower risk/lower reward post-event, which is much less crowded and not as nearly popular as pre-earnings announcement trades. However, on the long run, after-earnings announcement strategies are often better risk/reward strategies compared to before-earnings announcement strategies.

Dominant strategies are market directional buying or short selling stocks, but notable mention and often better risk/reward profile are directional, and long volatility strategies using options/option spreads, simply because traders can use almost all the available option strategies in the book to reflect directional price and long volatility bias.

Analysis is centered around market reaction to the earnings announcement (estimate vs. actual), and thereafter analyst statements and adjustments (upgrades/downgrades, price targets, etc.), that are key in defining and confirming stock sentiment and possibly directional bias for the current earnings quarter.

Our strategy for short-listing stocks with potential directional bias after-earnings announcement is similar as the strategy for the before-earnings announcements market directional short volatility strategy. The trades are typically initiated from several days to several weeks after the earnings announcement and can last anywhere from several weeks to the next quarter earnings announcement. The desired outcome is profit from market direction and eventual rise of implied volatility from the collapsed levels as it gets closer in time to the next quarterly earnings announcement.

Trading Strategies

  1. Bullish ATM Vertical Call spreads & Bearish ATM Vertical Put spreads
  2. Bullish OTM Butterfly Call spreads & Bearish OTM Butterfly Put spreads
  3. Bullish ATM Diagonal Call spreads & Bearish ATM Diagonal Put spread

Trading Conditions and Structure

  • Volatility - Relative implied volatility less than 20% of the yearly range.
  • Liquidity - Average stock volume >100,000, traded option volume >1,000, and option traded bid-ask spreads =<$0.10 - or stocks with weekly options expiration which by default assumes liquidity.
  • Strike Price - Varies to the directional bias trading strategy.
  • Trade Entry and Exit - Entry on the close up to several weeks after the earnings announcement, and exit on the close from several months after the earnings announcement to the next earnings announcement cycle.
  • Expiration - Closest expirations before the next earnings announcement cycle.

Trading Ideas

Focus period for the trading ideas ranges between the after-earnings announcements for the week of July 9th and before-earnings announcements for the week of July 16th. Below is a list of stocks that fit our criteria for trading market neutral and market directional strategies before and after earnings announcements.

Before-Earnings Announcement

  • Bullish: Alcoa (NYSE:AA), Cleveland-Cliffs (NYSE:CLF), VF Corporation (NYSE:VFC)
  • Neutral: Johnson & Johnson (NYSE:JNJ), W. W. Grainger (NYSE:GWW), IBM (NYSE:IBM), American Express (NYSE:AXP), United Rentals (NYSE:URI), Bank of New York Mellon (NYSE:BK), E-Trade (NASDAQ:ETFC)
  • Bearish: Kinder Morgan (NYSE:KMI), Genuine Parts (NYSE:GPC), Kansas City Southern (NYSE:KSU), Dover (NYSE:DOV)

After-Earnings Announcement

  • Bullish: PepsiCo (NYSE:PEP)

Particularly interesting to us are AA and AXP trades with specific trade recommendations below. Both should be initiated right before the earnings announcement, and exit after the earnings announcement or on expiration day.

AA - Bullish Tilted Iron Condor

Courtesy of TD Ameritrade ThinkorSwim

AXP - Neutral Strangle

Courtesy of TD Ameritrade ThinkorSwim

Conclusion

The methodology presented and strategies outlined in this article are just a framework and an idea that needs to be refined and detailed for every trading situation and trading style. However, they do offer a creative and alternative approach to trading the earnings announcements - as a stand-alone strategy or as an overlay to the main portfolio strategy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.