...and, now, the not so good earnings trades.
In my last post I discussed all my 'good trades' that worked perfectly. Unfortunately, this is not always the case. There are times when you might sell premium 1 or 1.5 standard deviations away and the stock price moves more than your expected comfort level, resulting in a loss post-earnings.
Despite this setback, I rarely close my position for a stop loss on earnings trades. Learning the defense mechanism to handle the loss (lower the loss or scratch the trade) or even turn the loser into a winner is an extremely valuable skill to have as a trader, and allows you keep your portfolio in the green.
I tackle bad earnings trades with a two-pronged approach:
Let's look at my earnings trade with Netflix which went against me at first, but turned around as I patiently worked through it:
The earnings were supposed to be announced after market close on Mon, July 17th. The MMM (market maker expected move) was around $11 for the options expiring that Friday (4 days away). With stock trading around $161, I opened a short strangle about 2 hours prior to close. The strikes I chose were 138 for puts and 185 for calls (this was more than twice the MMM expected move range). I sold 5 strangles (5 each of calls and puts). NFLX is a kind of stock that is typically range bound when there is no earnings, but during during earnings, it has a tendency to move 2 to 3 standard deviations. Though I was going out far on either side, there was still enough premium in there for my comfort level.
After the earnings announcement, NFLX opened around $176.12. Though it did not breach, the loss was significant. The first defense mechanism I used was to roll the short call (tested side) out in time to the following Friday while collecting additional credit.
Typically, I'd roll the put (untested side) closer to the call but given NFLX's propensity to move fast around earnings, and even post earnings, I left the put side as it was.
On Friday, July 21st, NFLX opened at 182.72; the puts were expiring worthless, so I sold the puts for the following week (but a lot more closer to the price action). I skewed it a bit by selling only 2 puts against the 5 short calls as I expected retracement of the gap created during earnings.
When the stock pulled back a little on July 27th, I sold some more puts (I was still skewed with more calls than puts). The stock had opened at 189.89 and went on to close at 182.68
Finally on another big move down on July 31st, I sold two more puts. The stock had opened at 184.26 and closed at 181.66
Within the next two days, I had completely scratched the trade and went on to make a profit, equivalent to the profit I had initially expected on my original trade.
Here is a log of the trades I placed for this position and an equity curve showing my P/L. As you can see from the P/L chart and equity curve, through rolling I was able to extend duration and turn around a bad trade. (Click image to enlarge)
Earnings trades come in two flavors: good and bad. But this doesn't mean our outcome needs to be a loss. By proactively repairing our bad trades, we can hope to either minimize the loss, scratch the trade, or make a profit!
I repeated by favorite Netflix earnings trade, this earnings cycle in October. This time the price stayed range-bound, making it a good trade.
Eighteen-year old trader, future connoisseur of options.
Follow me on Twitter!