Basing trades on public announcements and earnings reports can generate profits without a major investment of time
Investors always have something to trade, thanks to a six-and-a-half-hour equity trading day, extended hours for futures and weekend crypto markets. But not everybody has time to trade. It’s impossible to stay glued to the screen because other areas of life demand attention, and staying awake through the night hardly seems feasible. So, given a limited schedule, is there a more effective way to trade?
For busy investors, news-based trading provides a way to stay engaged with the markets. It’s exactly what it sounds like—buying and selling around a particular public event. Each month, dozens of market-moving announcements, such as Non-Farm Payroll reports, World Agricultural Supply and Demand Estimates, and Federal Reserve policy meetings, are released to the public. All of them present scalping opportunity. Besides those announcements, the hundreds of earnings reports released quarterly provide a nearly endless stream of short-term trading opportunities.
Consider earnings announcements. Each quarter, before a company releases its financial information, dozens of analysts make an educated guess on how the company performed. The difference between what they expect and what actually occurs can shake the stock price or not move it at all. It’s these guesses and expectations of movement that provide a great short-term opportunity for the savvy options trader.
Using options markets, traders can gauge how much market participants are expecting the underlying to move after the earnings release. This number is reflected in the implied volatility of the options expiring closest to the earnings date. Selling options around those price levels can be a profitable one-day trade if the stock moves less than expected.
Consider the example of a recent Apple (AAPL) earnings report. An earnings calendar shows Apple was releasing earnings on Wednesday, Oct. 30, after the market close. Using the implied volatility of the options expiring closest to the earnings release, Friday, Nov. 1, the market was expecting a move of +/- $12. With Apple trading around $243 on Oct. 30, the market was expecting it to stay within $255 and $231 before the options expired on Nov. 1. Using those ranges as a guide, a trader could sell premium around these prices to bet on an inside move.
An iron condor provides an ideal strategy for earnings plays because of its defined risk, lack of directional bias and low capital requirement. Given the expected move of +/- $12, a trader could sell the 225/220 and 260/265 iron condor for $0.76 at the close on Wednesday. The short options were placed beyond the expected move just in case Apple moved more than +/- $12. After the market closed, Apple released its financial performance and the next day opened higher at $247.24, a move of $4 relative to the expected +/- $12. With the price of Apple well within the iron condor’s short options, the trader could have bought back the spread for $0.03, a nice profit of $0.73 in less than 24 hours.
Traders can apply that strategy to countless earnings announcements if the underlying has heightened implied volatility and a liquid options market. Consider the recent release of Goldman Sachs (GS) earnings. Goldman Sachs released its earnings on Oct. 15 before the market open with the market expecting a +/- $7.50 move. Given Goldman Sachs’ closing price of $205.82, the 195/190 and 215/220 could have been sold beyond the expected move for $0.74 on Oct. 14. The next day, after the earnings release, traders could have bought back the iron condor for $0.13 because Goldman Sachs moved less than the market expected, a $0.61 profit in less than one day.
The key to these short-term earnings trades is finding underlyings with overpriced options. As the earnings date approaches, uncertainty increases, which pumps up the price of options. After the release, there’s no longer uncertainty because the earnings become public, and the option prices deflate like a balloon. This balloon release can be seen in the reduction in implied volatility; Apple’s implied volatility decreased from 76 to 28 while Goldman Sachs’ implied volatility decreased from 41 to 28.
In the search for short-term trading opportunities, consider earnings announcements and other public events with defined risk strategies. Earnings releases can provide consistent trading opportunity because the trades are short-term, the profit potential is high and the date of announcement is known ahead of time, removing the need to incessantly check price quotes.
Michael Gough works in business and product development at the Small Exchange, building index-based futures and professional partnerships.@small_exchange