Today is a bonanza for earnings. Whether they beat, miss or are in line, they are sure to illicit a reaction in emotions if not in price. There can be more to earnings than just the report though. We'll have the same runaround we do every earnings season where some will call it a pure gamble and others call it a mecca for potential profits.
For every grand slam you hear about, there will be four strikeouts in the book. But one for five can work, even in baseball, if that one hit is truly a grand slam. The key for trading earnings is to know there is no key. For some folks, it just won't work. For others, they will make you think it works, but their bottom line doesn't reflect that fact.
I have had some earnings seasons that were fantastic and others that were painful. While I agree pre-earnings trades can be incredibly difficult, the study that goes into them can be the very profitable part. So while I'll make small pre-earnings trades, I have found that more of my profits come from the trading after the release.
So why not just trade after the release and skip any pre-release positions? That would be logical, right? One would think so, but it isn't that easy. Without the prep work going into the trade, a post-earnings trade becomes more difficult. And without the emotional understanding of the trade, it becomes darn near impossible. Despite the prevalence of high-frequency trading (HFT), many traders are driven by emotion. Understanding that emotion by sometimes feeling it within yourself is a key for me.
Three names today have my focus today: Apple (AAPL), Facebook (FB) and F5 Networks (FFIV). I don't think any are a surprise as these names will likely pique the interest of most.
There are other approaches beyond simple directional bets and research worth doing before a report. For instance, if you've found yourself hammered by volatility decay in the past, then take a closer look at an option's implied volatility against the historic volatility. As an example, the at-the-money options for Facebook in April have an implied volatility (IV) in the 160% area against a historic volatility of 46%. One would have to move out to the June expiration to find calls and puts with an IV of 46%. Even May sits in the 60% area.
Apple has an IV of plus 62% for April expiration against a 14.75% historic IV. That could leave a mark. Even going out to June, we find an IV of 21%.
Meanwhile, FFIV is similar, as it is holding April options with a 115% IV against a 34% historic IV. May drops to 45% and June gets us to 36%.
So what does knowing the IV comparison offer you as a trader? Well, given the April options expire on Friday and the IV is likely to return closer to historic levels, it tells us that the volatility is a big component of buying calls or puts right now. The volatility is being driven by the unknown event and impact of earnings. By tomorrow, the unknown becomes the known and the IV will reflect the removal of a major catalyst. In other words, you can be right on the direction and still lose money. Therefore, if I am firm on a directional play I still may be better off with a June expiration. Heck, even if I want to play a big move, I may be better off going out into June -- or even a bit better off going out into May rather than using April.
When an IV is 3x or 4x the historic IV, as a buyer, you are definitely gambling on not just being right, but being really right. As a front month buyer, I would call this more gambling than anything, if -- and there is always an if -- but if this were the only information you were using. There can be times to buy the front month or front week, but I'm a bigger proponent in trying to use the high IV in front months to complement or offset positions in options with an IV much closer to that of the historic IV.
For me, this is step 1. I'll take a look at step 2 over on RMPro this afternoon and back here tomorrow morning.
At the time of publication, Collins had no positions in the stocks mentioned.