Option trading has many strategies for earning. A trader needs to understand the impact of the volatility, time decay factor, and pricing of the option contract.
Seasonal traders have amazing opportunities to trade in options and get the highest possible profit, but those days are highly volatile. There could be many reasons behind this high volatility, some internal factors like announcements of high profit and disclosing layoffs. The external factors may be currency rates, political factors and changes in government rules, etc. stock may observe a hike or a fall based on any of these factors.
Earning profit in option trading by applying various strategies depends on how well you know the leveraging facility available in options trading. How well you can leverage your stock or underlying asset decides your profitability. Many times, traders wonder about the happenings in the market after a wrong approach. Instead of checking - what went wrong from their side, they blame the market.
So, this page is for those who want higher earnings in the volatile market. You will see many options and strategies used by experts to earn profit in such harsh times. We shall further discuss:
What is the market situation at the time of earning announcements by the company?
How to use options as leverage after profit - announcements of the company.
Which options strategies must you NOT use or learn what to avoid?
Let us study all the above points in detail, one by one, to better understand which strategies to use while trading options.
Usage of options contracts after the company announces the profit:
How can a trader use options contracts after a company releases its earnings, and how does it profitably?
When the company releases its financial performance for the quarter, traders predict the financial performance of the next quarter based on this data. There may be some uncertainty during such times, but traders use this data to predict the next quarter's performance.
After the three months, when the next quarter's earnings are announced, traders and investors will compare the actual against the ones they predicted three months before. Even if the company has generated a good profit this quarter, if it has not exceeded the expectations of the traders, it may not get recognized in the market.
How the implied volatility works:
As we all know, the market is highly volatile during the season, as the traders have made predictions based on past data and expect their market predictions to come true. The assumptions of the traders are considered in the stock price.
Upon the release of the company data and knowing whether they met the predictions or missed out, the volatility vanishes from the market as traders now have the new data to process. Based on the quick and sudden reactions of the traders in that short duration, the stock market may move upwards and downwards.
The implied volatility can be understood as a trader's expectations towards the stock market. It is a degree of fluctuations based on the trader's expectations; the higher the expectations, the higher the movements. It is known as IV in the stock market, and the expectations of the investors drive it.
The implied volatility of a stock generally rises when the earnings are released. It may not be because of the volatile nature of the stock, but due to high uncertainty in the market during the announcement time.
With the increase in volatility, the traders expect to gain more profit leading to the high option's premium, and everything else is more expensive.
Understanding the concept of Volatility crush:
We have seen in the above section that volatility is the expectation of the stock market traders; on the other hand, volatility crush is when the market has revealed itself. After the release of the earnings, the traders start understanding and analyzing the actual data with their predictions, and the volatility disappears naturally from the market. This fading or natural decline of volatility is known as volatility crush. The drop in volatility may not always be seen, but the chances of experiencing it are high after the earnings by the company/ market.
We have understood the various concepts we needed to move further in learning strategies. Let us begin with the best strategies for earning. There are three primary strategies used for earnings:
Successful traders understand the concept of volatility crush and make the best use of the volatility. The strategies mentioned above considered two major things: one is volatility, and the other is a range-bound stock.
The short straddle option strategy:
In the short straddle strategy, the investor sells a call option and a put option with the same underlying stock, strike price, and expiry date. The traders' belief behind selling is that the stock will not have significant fluctuations until the time of expiry.
In this strategy, investors get their profit from less movement. Most importantly, it eliminates the task of predicting the direction of the stock and placing bets, hoping for a large move, either upwards or downwards.
The Short Strangles option strategy:
In a short strangle strategy, investors sell a slightly OTM call option and a put option of the same underlying asset with the same expiry date.
Generally, in this strategy, profit is limited while the risk is unlimited, here the Investors are the risk takers, they are willing to accept the risk if there is no or little movement in the stock price.
Investors can make a profit with the short strangle if, at expiry, the stock price is in-between the strike prices of the sold option. Here, options expire worthless, and the investors keep all the initial credit received (premium received by selling); thus, this strategy is called credit spreads.
Investors sell out-of-the-money calls upon entering the short strangles and put options at equidistance. Here the directional risk is reduced.
Kindly note, betting based on a single directional move during the peak time of options seasons is not a good choice. Rather, you must stay non-directional and adjust the strategy later.
If you don't want to sell the options contracts or buy any additional risk, try out this third strategy below.
Iron condor strategy:
Understand the process of buying and selling. In an Iron Condor strategy, investors buy a call and put options and sell a call and a put option. They sell a put option and buy another put option having a low strike price. In the same way, sell the call option and buy another having a higher strike price. All the options are from the same underlying asset and have the same expiry date.
Initially, you may find it confusing, but you will get used to it after practically using it once or twice in your position.
Iron condors also result in credit and generate upfront profit by creating a safety range. If, at the time of expiry, the stock is within that safety range; you will make a profit.
What to do after earnings? Shall I Exit my position or roll?
We have seen how to trade during the earnings and what strategies you can use to get the highest profit. But what after that?
There are always short breaks after the announcements as traders might get busy deciding the strategies. If the stock price is within the strike prices, you may exit the trade and close the position. It is something every trader might like to do.
But the market sometimes performs differently than we want it!
What if the stock moves beyond the strike price towards ITM?
Investors have a great choice of rolling their position, meaning they can close their current position and open new positions.
In the unfavorable scenario, your first thought should be to roll out the position to the next month and generate more premium. Suppose you have the contracts expiring in June Month; you may roll them for July month at the same strike price and receive additional credit.
You can roll the position based on the direction of the profit, that is, you may roll up or roll down your position Your chances of making a profit increase with these types of adjustments.
The announcements of earnings lead to uncertainty in the market. In the beginning phase, there is high implied volatility, and as the earnings are announced the volatility crashes. This concept will help traders and investors add new information and implement the most profitable options strategies.