On today’s episode of “Best Practices” Tom Sosnoff and Tony Battista examine earnings trades.
Publicly traded companies are required to report their earnings each quarter. The uncertainty around these of these announcements usually results in high implied volatility and high IV rank.
We trade earnings because, as seen in a "Market Measures" segment on 03/17/2015 implied volatility is generally overstated compared to the resulting stock move. The market speculation at earnings time presents us with an opportunity to trade an inflated volatility.
BOB subscribers receive a daily email that highlight upcoming earnings. The Grid page on Dough can sort underlyings by earnings dates.
No one knows how much a stock will move but the option prices tell us the market's expectations. A trader can take the price of the at-the-money straddle and multiply it by 0.85 to find the expected up or down move. An example using NFLX was provided and the process was explained. This can also be seen graphically on the Dough platform which highlights the week's expected range using this formula.
Earnings are binary events and random. Understanding that randomness tells us that it is a trader's premium selling that provides his statistical advantage and is what generates returns.
Generally speaking, we close or roll following the earnings announcement. If the position is being tested we will mechanically manage it and possibly look to extend duration.
Watch this segment of "Best Practices" with Tom Sosnoff and Tony Battista for a discussion on how to best trade earnings.
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