SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

How Earnings Impact Options Prices


Yesterday I closed our SE May 22.5 buy-write for a couple of reasons. First off, I knew that the position only had ~$0.20 more to gain over the next three weeks. I also knew those gains would take some time to capture as out-of-the-money puts (which is essentially what the May 22.5 buy-write is) hold their value until right before expiration.

(My full options education article on why buy-writes have the exact same risk/reward as selling naked puts is at the end of this article.)

The second reason I closed the position was there was a chance that SE would report earnings during the May expiration cycle. That would potentially bring another layer of risk to our May buy-write position. As you can see in the graphic below my options trading tool is estimating earnings will be reported the Wednesday before expiration, which would certainly keep the value of the buy-write high through earnings.

image.png

Another way I can determine when a company is due to report earnings is by comparing the volatility of the options each month. The volatility/price of options in the reporting month is higher than the months before and after earnings. Here is an example using Zendesk (ZEN), which will report earnings tonight:

image.png

What you can see in this graphic is that with the options expiring May 17 option volatility is 56.17, way more expensive than the June 21 option volatility, which is 41.77. In essence, the price of options/volatility is telling you that ZEN’s earnings are in the May option expiration.

Now let’s circle back to SE. Yesterday, the May option volatility in SE was significantly more expensive than June. And because of that I assumed that SE would report earnings in May.

However, based on a trade today, and how the options market is reacting to this trade, I now believe that SE’s earnings will come during the June expiration cycle, not May. First, here is the trade:

Seller of 7,500 Sea (SE) May 25 Calls for $1 – Stock at 25

Buyer of 7,500 Sea (SE) June 25 Calls for $1.90 – Stock at 25

This trade, and the subsequent volatility shift, would lead me to believe earnings are now in June. As the graphic below shows, the May volatility is down 6.7 points and now below the June volatility. Yesterday the May volatility was approximately four points higher than June … and today June is now 2.5 points higher than May (48.8 vs. 46.19).

image.png

The earnings date for SE is still not confirmed. However, by paying attention to the price of options/volatility you can get a good read on when the options market is predicting a company will report.
 

Below is an options education article I wrote several years ago demonstrating that while Covered Calls/Buy-writes are considered a safe trade, and Naked Put Sales are perceived to have high risk, at the end of the day they have the EXACT same risk/reward. 

Buy-Write vs. Naked Put Sale

Buy-writes, also known as covered calls, are one of the general public’s most popular options trading strategies. Selling naked puts (the sale of a put in an stock or index without a stock position), on the other hand, is feared by the general public as it’s considered to have much greater risk than a traditional buy-write. But when you break down the profit and loss potential of the two strategies, you can see that they’re identical.

Let’s start by looking at a buy-write/covered call:   

A covered call is a strategy in which the trader holds a long position in a stock and writes (sells) a call option on the same stock in an attempt to generate income. Because the trader sold a call against his stock position, his upside is now limited.

For example, let’s say you own 100 shares of Alcoa (AA), which is currently trading at 13.99. You then theoretically sell one AA July 14 Call (expiring 7/19/2014) for $0.51 for each of your 100 shares.

Let’s take a look at a few scenarios for this trade:

  1. In this scenario, AA shares trade flat for the next month and the stock stays below the 14-strike price. At this point, the options you sold will expire worthless, and you will have collected your full premium of $0.51 per share ($51). Thus you will have created a yield of 3.78% in one month’s time.
     
  2. In this scenario, AA shares fall to 13.48. At this point, the options you sold will expire worthless and you will have collected your full premium of $0.51 per share ($51). However, your 100 shares of AA will have lost $51 of value. Thus, you are breakeven on the trade. At this time, you could simply sell the next month’s calls against your stock position.
     
  3. In this scenario, AA shares fall to 13. Once again, the options you sold will expire worthless and you will have collected your full premium of $0.51 (or $51). However, your shares of AA will have lost $99 of value, leaving you down $48 on the trade. At this time, you could simply sell the next month’s calls against your stock or exit the entire position by selling your stock.
     
  4. In this scenario, AA shares rise above 14. At this point, the owner of the 14 calls will exercise his right to buy the stock from you. This will leave you with no position. However, you have collected your $0.51 (or $51) and made $0.01 on the stock position.


Here is the profit and loss graph of this trade:

image.png


Now let’s take a look at the scenarios of selling a Naked Put in the same stock. (Remember, selling naked puts is the sale of a put in a stock or index without a stock position.) With stock AA trading at 13.99, we could sell the July 14 Puts (expiring 7/19/2014) for $0.51.

Let’s take a look at a few scenarios for this trade:

  1. In this scenario, AA shares trade flat for the next month and the stock stays below the 14-strike price. At this point, the options you sold will expire in the money, and you will have collected your premium of $0.51 per share ($51). Now you will be long the stock, but will have created a yield of 3.78% in one month’s time. At this time, you could simply sell the next month’s calls against your stock position.
     
  2. In this scenario, AA shares fall to 13.48. At this point, the puts you sold will expire in the money.  Thus you will buy the stock at 14.  However, since you collected your full premium of $0.51 per share ($51) this makes up for the loss on the stock. Thus, you are breakeven on the trade. At this time, you could simply sell the next month’s calls (switching to a buy-write now that you own shares) against your stock position.
     
  3. In this scenario, AA shares fall to 13. At this point, your puts are in the money so you will be forced to buy the stock at 14. You will have collected your full premium of $0.51 (or $51). However, your shares of AA will have lost $99 of value, making you down $48 on the trade. At this time, you could simply sell the next month’s calls against your stock or exit the entire position by selling your stock.
     
  4. In this scenario, AA shares rise above 14. At this point, the puts you sold will expire worthless and you will have collected your full premium of $0.51, or a yield of 3.78%.


Here is the profit and loss graph of this trade:

image.png

 
So what jumps out about these two charts? They are absolutely identical! The most you can make is the same, and the most you can lose is the same.

We can go through this exercise hundreds of times but each time the profit and loss graphs will be identical. Thus, executing a buy-write is “synthetically” identical to selling a naked put.

Jacob Mintz is a professional options trader and editor of Cabot Options Trader. He is also the founder of OptionsAce.com, an options mentoring program for novice to experienced traders. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations. Jacob developed his proprietary risk management system during his years as an options market maker on the Chicago Board of Options Exchange and at a top tier options trading company from 1999 - 2012. You can follow Jacob on Twitter.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Important Tips For First Time Currency Traders

    Diversifying your portfolio is important for all investors, and currency investments are a great way to do that. However, there are a lot of misconceptions and common mistakes that first time currency investors make, and this leads to big losses.

    By Kim,

    • 0 comments
    • 75 views
  • Iron Condors or Short Strangles?

    In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

    By Jesse,

    • 0 comments
    • 1,201 views
  • How To Be A Successful Day Trader From Home

    The good news is that if trading is your passion, then it’s possible to become a successful day trader and work from home. However, it’s not as easy as setting up shop and jumping online. There are specific steps and processes you need to have in place if you’re going to be able to make a living for yourself and have a bright career and future.

    By Kim,

    • 0 comments
    • 154 views
  • 3 Key Pieces Of Advice For New Traders

    These days, everyone claims to be an ‘expert’ on absolutely everything. Apparently, it only takes having a Twitter account to be a seasoned expert on any given subject; all in all, the Internet is full of nonsense. It’s becoming harder and harder to find legitimate answers amongst the quagmire of false information online.

    By Kim,

    • 0 comments
    • 215 views
  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 411 views
  • Lumpy Dividends and Options

    Dividend payments, like oatmeal, may be smooth or lumpy. Smooth dividends are predictable, usually once per quarter. It is easy for options traders to believe these dividends are guaranteed, because they usually continue uninterrupted quarter after quarter. This also makes it easy to predict total return over a longer time span.

    By Michael C. Thomsett,

    • 0 comments
    • 384 views
  • Coming to Peace With Market Volatility: Part II

    On April 18th I wrote part I of this article, Coming to Peace With Market Volatility. I showed how the US equity market risk premium, defined as the annual average return of the Total Market minus the return of one-month US Treasury Bills, was a large 8.37% per year from 1950-2019. That’s the good news.

    By Jesse,

    • 0 comments
    • 421 views
  • Ratio Calendar Spreads

    The ratio calendar spread is well-known to some, but for others the risk/reward aspects are not well understood. One way to cover a short position is to own 100 shares of the underlying stock. Another, more creative way is to sell a shorter-term expiration position and buy a longer-term position.

    By Michael C. Thomsett,

    • 0 comments
    • 831 views
  • Studies Vs. Real Trading

    "Who you gonna believe, me or your lying eyes?" Our members and readers know that buying pre earnings straddles has been one of our favorite strategies that produced consistent gains in the last 8 years with very low risk. Yet there is a significant number of studies showing that this strategy has a negative expectation. 

    By Kim,

    • 0 comments
    • 776 views
  • Should You Hedge or Diversify?

    Using the most popular S&P 500 ETF (SPY) to represent the US stock market, this article will look at different ways to manage equity market risk using historical ETF and options data from ORATS Wheel since 2007. We will analyze the following unhedged, hedged and allocation choices:

    By Jesse,

    • 11 comments
    • 1,149 views

  Report Article

We want to hear from you!


There are no comments to display.



Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido