By: Tom Gentile
on January 23rd, 2024
Our best guide to successful trades is historic performance. If you can find a stock that repeatedly rises into earnings or repeatedly drops into earnings coupled with Implied Volatility (IV) rush, you have a good chance of history repeating. As I’ve spoken about in prior articles, this is at the heart of my directional earnings trades. Get direction right most of the time using history and amplify profits with pre-earnings IV rush. AND, when history doesn’t repeat lose less money due to IV rush.
Now, some stocks don’t move consistently up or consistently down into earnings. However, some do move hard up AND down consistently into earnings.
Notice that the stock ran up hard two earnings announcements prior and then down one earnings announcement prior (green “E” triangles are earnings announcement dates).
Of course, we can’t on the stock moving up or down given the mixed directional movement the prior two earnings, so buying a call or put is a 50/50 proposition.
That’s where straddles come in. We can literally place both sides of the fence by buying a call AND a put. The call will make more money than the puts lose if the stock rises and vice versa.
All of this can easily be seen in a risk graph.
The above risk graph illustrates the profit and loss situation of straddling CAG. Buying an October 6, 2023 $29 Call and buying an October 6, 2023 $29 Put creates a straddle that will profit should CAG move anywhere.
Of course, there is risk if CAG doesn’t move as illustrated by the “witches hat” portion of the risk graph. As time erodes, value bleeds out of the option. The red, blue, green and black angular line are 4 snapshots in time that illustrate time decay. Max risk in the straddle lives at expiration on October 6, 2023 at the straddle strike price of $29.
Working against time decay is Implied Volatility (IV) rush. We know IV will rush into earnings, so even if the stock doesn’t move, we can count on losing less than if we didn’t have the benefit of pending IV rush.
Scouring stocks and crunching numbers would be far too time-consuming, so I use scanners to find these trades for me.
Below is the scan result for CAG revealing that straddling CAG 24-days before earnings produced an average 54.14% ROI and a massive IV rush of 288.78% over the past 2 earnings.
History. Plain and simple.
Will it repeat?
Most of the time it does, and with the built-in risk mitigation of earnings straddles coupled with IV rush into earnings, winners normally outpace the winners.
Let’s see how this trade did.
Here is the risk graph page on the entry date of 9/11/23:
We had $447 of risk on this trade with the plan to exit on 10/4/23, the night before earnings the morning of 10/5/23 (BMO).
Here’s how the straddle looked on the exit date of 10/4/23.
The stock tanked into earnings (like it did the prior earnings period) netting a 56.4% profit.
Now, the secret sauce is the IV rush. IV rush increases option premiums across various strike prices.
The IV charts below reveal IV on the entry date and IV on the exit date.
The options purchased on 9/11/23 were a lot more expensive on the exit date of 10/4/23.
Simply said, the large IV rush added more profit to our trade.
Optimizing entry dates for pre-earnings straddles requires computers, however, some general rules of thumb to use would be:
- Find stocks that consistently move big into earnings.
- Place an ATM (strike close to stock price) 7-days into earnings.
- Use the first expiration date available AFTER the earnings date.
Be sure to practice without using real money until you derive a system that produces consistent overall profits.
— Tom Gentile
C1P: Chief 1-Percenter
App: Toms Option Tools
Toms Option Tools scan the markets for bullish and bearish trade opportunities using our proprietary scans and strategy algorithms. TTR Darknet finds bullish entries based on triple stack channel collisions. Money Calendar identifies seasonal patterns with at least 90% accuracy looking back 10 years. Weekly Cash Clock finds short term opportunities that last a week on average. Microcurrency Trader applies Darknet technology and moving averages to cryptocurrencies. Velocity Trader utilizes volume spike and Velocity indicators on custom stock lists. Quantum Scripts scans the markets for momentum acceleration signals and employs Quantum noise filters. Optimal Trader finds directional pre-earnings opportunities that are optimized for entry date, stock movement, and volatility surge. My Trades tracks the profit/loss of your trades, displays stock charts and risk graphs, creates new trades, and edits existing trades. Morning Report provides top 10 option rankings in 6 categories each day.
Stock and options trading has large potential rewards, but also large potential risk.
You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.
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Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.
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