Earnings: Fading Big Moves
Aug 29, 2017
By: Sage Anderson
The corporate earnings season is a very important period on the options trading calendar.
Whether it’s big swings in implied volatility or crazy moves in underlying stocks, profitability reports from companies across the trading universe provide traders with a myriad of opportunities.
There are also a wide variety of approaches that traders can take when filtering for trading ideas during the earnings season. This may include the sale of inflated implied volatility, a pairs trade involving two competing companies, or a trade that leverages the aftermath of the earnings move.
Today on the blog, we’re zeroing in on one particular trading approach related to corporate earnings.
Specifically, those instances when a company reports earnings and the underlying stock makes a big move during the trading day immediately following the report. For the purposes of this discussion, a "big move" equates to a stock moving up or down more than 5%.
The foundation of this trade relies upon the assumption that an earnings release represents a brief time when investors have access to almost all of the most important information relevant to a company's operations and outlook.
While this transfer of information may result in an immediate re-pricing of the underlying stock (i.e. "big move"), it also means that a theoretically "efficient market” has likely arrived at fair value for the shares.
Given that future news related to the company's operations and outlook will take time to develop (i.e. the next earnings report), that means there's a window of time in which the stock may trade in a relatively tight range.
To leverage this situation, many traders and trading firms sell premium in post-earnings names with the hope of capitalizing on this potential opportunity. This is especially true when traders have a good understanding of “the story” in the underlying stock.
A recent episode of Market Measures covers this precise topic, and we think the information contained within is worth a few moments of your time.
On the show, a study is presented that examines the historical success of selling premium in stocks that made “big moves” after earnings.
The specific position structures back-tested in the study were call and put spreads, which are defined risk structures. However, depending on your experience and risk profile, there are certainly other structures that might be used (straddles, strangles, short puts, short calls).
The parameters of the study are important and relatively easy to understand.
Using six stocks (AAPL, AMZN, FB, MSFT, NFLX, TSLA), the Market Measures team used data going back to 2005. For earnings that resulted in "big moves," a put spread was sold if the stock went down more than 5%, while a call spread was sold if the stock went up more than 5%.
In both cases, the spreads incorporated a 50 delta leg and a 10 delta leg (sold the 50 delta, purchased the 10 delta). The aggregated profit/loss results from this study are shown in the graphic below:
As you can see from the information above, fading downside moves produced more favorable results than fading upside moves. On average, selling put spreads in these six stocks after a big move resulted in positive returns.
Interestingly, the results of this study also reinforce previous tastytrade research (presented on Market Measures) that analyzed selling puts in Blue Chip stocks in the wake of a big down move (again, more than 5%).
If you think this approach fits your outlook and risk profile, we hope you'll take the time to review both aforementioned episodes of Market Measures when your schedule allows. It’s possible you might be able to add this approach to your quiver of strategies.
If you have any questions about fading big moves, or any other trading-related topic, we hope you’ll reach out at email@example.com, or leave a message in the space below.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.