Corporate earnings is an event that comes along every quarter. While this development does change stock price expectation, it also is a source of volatility due to the change in performance of the company declaring result.
This volatility and the expectation of such volatility priced into Options of the stock provides us with many trading opportunities as well as a lot of information about the market consensus expectation from the event of result.
First, we look at the Indication that Options provide about the expectation from the event. Then we will look at trading options with the information that we have acquired.
We all know now that option premiums are dictated by the sellers of the options. Just like Insurance premiums are dictated by the Insurance Sellers (Insurance companies). Now, consider result season as the time of infection season like monsoons (where there is more risk of disease). If there is more risk, the insurance sellers or in our case option sellers will command more premium.
Now the option sellers have only option premium to cover any loss created by the volatility due to the event of result. So, ahead of these results the risen option premiums give us an indication of movement expectation post result or due to result.
How do we come to know about it?
A simple technique can tell us the expected movement post result. The formula for this is very simple. Just add the Call Premium and Put Premium of the strike close to the current market price. The added sum that we get can be added and subtracted from the Strike Price and what we get is the post result expected or estimated range.
Example: With 2 Days to result announcement Stock X trades at 100 with
100 Call @ 3
100 Put @ 4
Total Premium of 100 Call + 100 Put = 7
Post Result Expected Range = 100 – 7 to 100 +7 = 93 to 107
Now comes the part of trading these indications that we have. Estimating the direction post the event of result is very difficult. In fact, any event for that matter comes with uncertainty. It is difficult to predict if the stock will go up or down post the event like result.
However, we do have the indication of expectation from result, which can be used as an input here.
If we believe the stock can go beyond the range of 93-107 then we could Buy both Call and Put. If our expectation is correct and the stock does go above 107 or below 93, one will get money out of the trade due to extra movement.
On the other hand, there are traders who may feel the Estimated Range of 93-107 is too big and the movement may not be so big. In such case, there are option traders who sell both Call and Put options with strike that is close to current market price of the stock. The same can be bought back right after the result to exit the trade.
However, this trade is very risky because the movements after result are very fast. Also, if the result is announced before market hours or after market hours, the gap opening may not let us buy back the sold option (when our expectation of movement is wrong, and the movement is bigger).
For such cases, many traders also Buy a Higher strike Call and a Lower strike Put compared to the Call and Put we sold. This helps in restricting the loss if we go wrong. On the other hand, the premium paid on buying the additional Call and Put will lower the profit, but it is safer this way.
These are major Result Season Option Trading Strategies.
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