Using Options to Play Earnings Long Before Expiration

By Steve Smith Earnings reports often offer short-term trading opportunities in which the selective use of options can deliver outsized profits. When the options being employed are close to expiration the returns can be even further amplified as gamma increases as expiration approaches. The accelerated impact offered by the immediate decline in implied volatility and evaporation of time decay can be an attractive lure for speculative positioning. For those who used options last week to play high-flying momentum names such as F5 Networks (FFIV) or Juniper Networks (JNPR), the results were fast and large. And if you were using options that expired last Friday, results were pretty final unless you were willing to turn a trade into a position by extending into a later expiration. Otherwise there are few options and little time for making adjustments to minimize losses when wrong.

(To read Lloyd Khaner's piece on stocks screaming for a correction, click here.)

Time to Play Out Now with another three weeks until the February options expire one can approach earnings reports with a little wiggle room in terms of both expectations and strategy implementation. When there's only a few days remaining until expiration you basically need to be in a predictive mode in terms of stock direction and whether the stock will exceed the amount priced into the options based on implied volatility. When there is several weeks remaining you still want to get the direction right but the magnitude of the move doesn't need to be as accurate for the position to be profitable. Even if the initial move is only a small percentage it may establish the stock's trend for the next few weeks, which will give your position time to play out. IBM (IBM) is a great example of a stock extending the initial move, having now added another 4% since it reported last week. If you bought an option outright you now have an edge in making some adjustments, such as legging into a spread or taking partial profits and rolling into a higher strike.

(To view Wayne Ferbert's piece on the advantages of long term hedging, click here.)

If you were directionally wrong the options you owned will still retain some time premium to allow you to salvage some value. Get Reactive Unlike previous quarters where we saw many stocks gap higher following earnings reports, the general response to this season's earnings is taking on a bearish bias ranging from shape extreme punishment to essential indifference.

(To see J.W. Jones warnings to options traders regarding Netflix Earnings, click here.) With this in mind it might make sense to wait until after an earnings report to react, rather than anticipate the first move. As we are seeing, even if one believes the selling is an overreaction it often continues for several days. In these cases one might take the approach of selling a call spread with the notion it will take a while for the stock to resume its momentum and a ceiling has been placed on its price. Another approach would be to wait a few days until a support level is reached and then establish a low-cost bullish position.

To read the rest, head over to Minyanville