Hey everybody, Gracer here from the tastylive Research Team.
Earnings are a big part of trading. Love ‘em or hate ‘em, earnings definitely provide us with tons of opportunities to place trades. When we have a directional assumption on the underlying, we’ll often use a debit spread to play the earnings announcement. But debit spreads are generally a 50/50, “risk one to make one” shot.
So we decided to test one way to reduce our cost basis on earnings plays: by selling a naked OTM call in order to finance our debit spread AND increase our probability of profit. We call this debit spread with an OTM call a “sunny side up.”
Selling the additional call moves our risk from the downside to the upside. So as long as the underlying doesn’t have a larger than expected move, we’ll see a profit.
We tested two strategies against four years of earnings in a bunch of underlyings. First, the ATM call debit spread and then the “sunny side up” version; the ATM call debit spread with the additional short call.
Turns out that the “sunny side up” strategy increased our win rate from 53% all the way to 80%. On top of that,we were able to double our profits…from $1,138 to $2,047.
Bottom line: even though the “sunny side up” has more upside risk, we feel it’s justified by the increased win rate and overall profitability.
If you want to take a closer look at this research, check out the full episode by clicking here. I bet you will not believe how many more amazing pieces are in there.
OK, I’m Chris Grace, on behalf of the rest of the research team. Thanks for watching my Market Measures Notebook!
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