How to Trade Tomorrow's Earnings

The market continues to see an uptick in volatility while simultaneously printing higher stock prices. This usually means there is a topping formation in progress. That said, financials continue to move constructively northward and the heels of earnings for American Express (AXP) take place on Friday morning.

So today we're looking at a bullish trade on AXP's earnings.

Today's trade will be a long call butterfly spread. When we position with long call butterfly spreads, we attempt to collect a premium that is generated by a strong move in the underlying stock's chart. We offset the cost of the long calls into earnings with a short call spread that mitigates some of the risk premium incurred taking the position

Trade structure – the long call butterfly with a twist

The long call butterfly consists of two spreads – a long call spread and a short call spread that attempts to capture the potential upward spike in price from the earnings release. To help pay for this position we will sell a short call spread to collect a premium.

AXP's stock price is currently range bound with resistance near $340 and support near $300. With that in mind, here's the trade:

• Buy to open 1 AXP 21 Feb 330 calls
• Sell to open 1 AXP 21 Feb 340 calls
• Buy to open 1 AXP 21 Feb 345 calls

At this writing the debit cost is $1.90 and the maximum profit will be the distance between the first two strikes (330 and 340), which is $10, less the cost of $1.90 = $8.10 or $810. Notice, however, that the short call spread is only $5 wide, so if the price action shoots past $345, we would still have $5 from the first spread, less the cost – and this would still deliver over 150% gains.

Our maximum risk is simply the cost of the spread – if the price action fades, or does not rise past $330, we will lose the cost of the debit.

Trade Management

The strategy result provides three ways to exit the trade:

1. Sell the butterfly once it gets to an acceptable profit margin for you. I customarily look for 150%-300% profit for these kinds of trades in the current environment of volatility.
2. Sell the butterfly once it hits a loss threshold as determined by personal risk – this will happen with extreme movement. I customarily look at about 70% though depending on my size.
3. Ssell the butterfly into the week before expiration, if all is going well and you have decided to hold the trade into closer to the end of expiration (I have had many a trade go sideways taking it down to the wire and not capturing gains, so I do not advise this).

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