This One Simple Strategy Can Yield Explosive Results...
Here's another incredible options trading strategy that can be played during one of the most volatile times of the year - earnings season.
Earnings season is a time when all publicly traded companies must show their financial results to the investing public.
It happens four times a year and we'll usually witness incredible moves - both higher and lower.
Many of my readers, including myself, would like to be able to capitalize on those large moves. Problem is, we have no way of knowing ahead of time if the stock is going up or down after the report is out.
If you lean to one side, i.e., get long, and the company craps out, you're stuck with a fast losing trade. If you decide to short a stock before earnings and it explodes higher, you're looking at potentially unlimited losses. That's scary!
So should we just crawl back into our holes and accept that fact that we'll never be able to take advantage of these opportunities, or should we discuss an incredible option trading strategy that is made especially for earnings season?
I say we discuss. Yes?
"Strangle" Is The Name Of The Game
Option strategies have weird and funny names, don't they?
I didn't make them up, but the strangle could be your best friend during earnings season.
Why?
Because it is an option strategy that can make big profits no matter which way the stock moves.
How?
By buying both a call option and put option at the same time. Genius!
Since call option buying is a bullish strategy and put option buying is a bearish strategy, you are essentially covering both sides of the trade. And if the stock moves far enough in either direction, you can walk away a huge winner.
Although I'm not a huge fan of option-buying strategies, and that we execute put-option sales in my Smart Option Seller newsletter, I like to give my readers an extra bit of love by offering other "unofficial" profit-making opportunities from time to time. We've employed the strangle a handful of times, some of which were very successful.
Here's How It Works
Pick a stock that has had large moves in the past after its earnings are announced. This would typically require a quick glance at its stock chart over the past year or so.
Take a look at this chart of Target (TGT):
You can see the many gap moves in TGT during this span in 2016-2017, most of which occurred during an earnings announcement. Both gap ups and gap downs occurred, but more gaps were to the downside.
This is key when using the strangle strategy, because you want to hone in on a stock that has the capability to move a big distance. It's not recommended on stocks that are quite stable and have a history of small moves around earnings.
In order to play a trade like this, you would want to buy the nearest-term expiration out-of-the-money (OTM) call and put options that are relatively cheap within the distance of the recent gap moves. And by relatively cheap, I mean options that cost $.25 per contract or less. That's my version of cheap.
In this case, the maximum cost would be $50 total investment if buying just one call and one put option contract. Buying ten of each would be an outlay of $500. You choose your wager.
Now, which strikes should be bought?
You want to key in on how far a stock typically moved after prior earnings announcements. In this case, we can see TGT tends to gap higher or lower by as much as $5 per share in many instances.
Once you have an idea of how far the stock can move, you then scan through the options contracts to find those cheap options that are within, or close to, a $5 radius (in TGT's case) of the stock's current price before earnings are announced.
Make sure you use the closest-dated expiring options. Many stocks have weekly expirations, so if the company announces earnings on a Tuesday for example, you would pick that Friday's expiration. This would give just a few days to see the trade play out. That's all the time you need.
The reason we target the nearest expiration is because those are the cheapest options on a dollar basis.
Since these speculative trades can have a high degree of expiring worthless, we want to use the cheapest priced options. This way, if we lose, we don't lose too much.
Here's one of our best earnings trades that we executed in the Smart Option Seller on this exact Target trade.
On February 27, 2017, I alerted my readers to buy as an "unofficial" trade, the March 3, 2017 $60 put options for $.05 per contract. This trade cost just $5 in total. 10 contracts would cost $50, and 100 contracts would cost $500.
Although we only bought the put options in this case, we could've easily purchased the $73 strike call options as well for $.05 per contract. This would've been classified as the TGT March 3, 2017 $60/$73 strangle for $.10 per contract debit.
Since the whole strangle would've cost $.10 per, it only would've been a $10 loss if the options expired worthless.
How Do You Make A Profit?
Here's how it has to work in order for the strangle to pay off.
The stock has to move very close to, or beyond, either one of the strike prices in order to see a gain.
In the TGT $60/$73 strangle, the stock would need to move above $73.10 or below $59.90 in order to at least break even. It doesn't matter which way the stock moves as long as it surpasses either one of those thresholds.
How do we calculate that?
You add and subtract the $.10 cost to the $60 and $73 strikes. As long as TGT moves beyond those thresholds ($59.90 or $73.10), the trade will be a winner.
If you look back at the chart above, we played the last gap move shown on February 27, 2017. TGT stock was trading at roughly $67 before the earnings were released. The next day on February 28, 2017, it gapped open below $60 and kept going. This was a huge windfall for us.
Here are some of my readers comments from the next day:
How to turn $121.43 yesterday into $3978.47 today?
Just follow Lee Lowell's recommendations.
All of them!
Bought 20 contracts of that Target $60 3/3/2017 hedge yesterday, as recommended, for $.05. Total, with commissions: $121.43.
Sold them at the open today for $3978.47 (net after commissions; could have gotten a little more if I had waited, but you know what happens to pigs in the market!).
Lee, can we do this every day??!! Please? -Dave M.
--------------------------------------------------------------------
Yesterday I Bought 4 TGT Mar 3 2017 60.0 Put @ 0.05 and just Sold 2 TGT Mar 03 2017 60.0 Put @ 2.07 Just under $800 after fees. Very nice target of opportunity! (Pun intended) Just paid for this years membership fee (and then some). Thanks, Chris D.
--------------------------------------------------------------------
Lee,
I love you.
I bought 50 contracts of TGT at the 60 strike for .05 yesterday at your recommendation. I sold this am for $2.58 for a profit of $12,626.
My best trade ever. Thank you so much!!!!!!!!!
So glad that you are back in business. -Julie T.
---------------------------------------------------------------------
75 contracts. In at 0.04 and out at 2.06. Nice play. Thank you. - Marty S.
---------------------------------------------------------------------
great call Lee bought at .05 and sold at 2.06 - Robert B.
---------------------------------------------------------------------
THANK YOU! Just booked a week in Antigua Sandals thanks to you. LOVE UR Service. - Albert P.
----------------------------------------------------------------------
Thank you Lee, for the slick play! I bought 100 TGT @ .05 and STC @ 1.71! - Frank S.
----------------------------------------------------------------------
Those were great actual results by some of my readers. If you do the math on the last comment for example, that was a gain of $16,600 overnight. A return on investment of 3,320%!
TGT was trading at $67 before the earnings were announced. We chose the $60 strike put options, which were $7 away from the $67 stock price. That was a bit further away from the $5 radius that TGT usually moves, but I felt confident that it could work for us. And it did indeed.
The breakeven level for the put option was at a stock price of $59.90. TGT continued to move even lower, and that's how my readers were able to sell the put option for such a huge gain.
Are There Downsides?
As great as the strangle sounds, there are of course risks, but these can be minimized.
Number one, sometimes stocks go nowhere after earnings are announced. This is the worst-case scenario.
If that happens, there’s very little chance the stock will move beyond it’s typical gap radius and the options will die extremely quickly.
Number two, volatility will collapse after the results are reported. This also has the effect of deflating the option prices.
You see, before earnings are announced, there’s lots of uncertainty on which way the stock will move. This causes lots of uneasiness in the options market and their prices get bid up to unusually high levels. The market-makers don’t want to get caught in a bad way, so they tend to inflate the costs.
And once the earnings are announced and the uncertainty is gone, the volatility disappears, bringing the option prices down with it.
This will happen regardless of which way the stock eventually moves. That’s why it’s imperative to lock in any gains very quickly.
And to combat the case of the stock going nowhere after the report, make sure you stick to buying strangle strikes within the typical gap radius. That gives you the best shot.
To conclude:
If you want to play a potential large move in a stock before earnings are announced, here are the best strangle steps:
1. Find a stock that has had large moves in the past.
2. Buy both the nearest-term OTM call and put options at strike prices that are within the stock's typical gap radius. If a stock typically only gaps higher or lower by $2 per share, it doesn't make sense to buy option strikes that are $6 away.
3. Try to buy the cheapest priced options within that radius. My goal is $.25 per contract or less.
4. You want to buy both a put and call option as you never know which way the stock could move.
5. If the stock makes the big move, take your profits quickly, as they can evaporate just as fast.
6. Don't bet too much, as these trades have only a few days of opportunity and the loss rate can be quite high.
Send me comments and questions on this strategy. Give me your success (or failure) stories. I'd love to hear.
I'm always scanning for trades like these in our newsletter. I do all the work! Come join us.
Enjoy!
- Lee