Trading an earnings phenomenon

A Tuesday Trade Edition: One of the most important concepts in trading is to review your work, and learn from the good and the bad. It’s critical to identify what’s working — to do more of it. Each week, you’ll get a trade from my trading journal, in which I explain my whole thought process from start to finish. Trading is all about finding something that works, and applying it, over and over again. That’s how you find trading success. So study up on this “Tuesday Trade” and let’s get to work.

Today’s let’s focus and earnings trade I took in Costco. This trade is a little bit different from the normal directional momentum trades that I do, but the reason that I like earnings trades?

Because they provide overnight opportunity.

Here’s how to make easy money, while you sleep…

Background Work:

When I’m looking to do analysis for an earnings trade, I like to go back about 8 quarters, and look at how the stock performed before, during, and after reporting earnings. Knowing how a stock traditionally reacts is crucial to trading earnings.

Now you can see that majority of the time, Costco actually traded lower after earnings, but not by that much. For the most part the moves were less than $8 (and on a regular basis less than $5).

So for this reason I decided to sell an iron condor, so that I could take advantage of a phenomenon called the IV crush.

What’s The IV Crush?

Basically what happens is prior to an earnings report the implied volatility (IV) in the options market gets up to a peak. You can see the implied volatility right here in this screenshot:

In the screenshot above the implied volatility for Costco was 74.53%.

Now what happens is because the implied volatility is so juiced up, the price of the option is elevated. And the price is elevated because of an event, which in this case is the earnings report, that’s going to cause volatility. When the options cost more than normal like this, I like to take advantage of that by selling an iron condor.

But why an iron condor?

I chose an iron condor in this instance because I didn’t care if the price went up or down, I just wanted it to stay within a certain range. Now I actually had two iron condors on this ticker, but I want to focus on one in particular…

The 340 Iron Condor:

So I sold a 340, 325 put credit spread on Costco, and then I also sold a 340, 355 call credit spread. This is the range that Costco needed to stay within.

I was able to sell this for $10.23, which meant that if Costco traded up $10 or down $10, it would break even. However, if it traded in a move less than $10, I’d make money overnight. How? Because I was trading the IV crush phenomenon, so we could expect that that IV was going to be crushed. That meant the price of the option was going to be lower the day after earnings than it was before. And if Costco didn’t move within a wide range, we could’ve made money via premium decay.

So I went ahead and sold that for $10.23 in my Stacked Profits Mastery program. But the especially cool part?

I worked through this whole trade during our monthly Live Trading session, so all the members could trade along with me and watch it unfold in real-time. I actually ended up trading a couple other trades as well in the Mastery around the same time (another iron condor and some unbalanced butterflies). So if this particular trade wasn’t your speed, there were others to choose from. If you want in on the next session, join my Mastery here.

Now For The Profit:

I bought back the iron condor at $4.77 — that was a little more than 50% overnight. Since it was less than an $8 move, we made money just on the fact that Costco barely moved. While it’s always fun to trade massive moves in the market, I wanted to show this trade as it’s a favorite of mine for trading earnings because it shows that you can profit on barely any move at all.

P.S. it’s not too late to get in on Simpler’s Course of the Month for September. This month we’re featuring my “Short Interest Secrets” class, which I’ve been highlighting in most of my recent Tuesday Trades. If you’re interested in the awesome discount available, follow this link or click on the image below before October 1st.

2 thoughts on “Trading an earnings phenomenon”

  1. Danielle – I am a fairly new trader and trying to get ahead. I studied option fundamentals for several months (I am a production designer for major touring rock bands and our business came to a screeching halt on March 6), started trading with paper TOS since June and recently moved to live while continually watching different videos and reading to garner the best strategies.
    The business is fascinating and I am learning what I want to risk and the time that I want to spend at it each day. Some lessons are painful!
    I am member of Simplier, taking baby steps with the strategies and letting it really sink in. Your video on Butterflies are intriguing and I followed your NVDA setup with one contract in 3 positions – it is still open with 9 days to go.
    I have done a few credit spreads, but the close of these trades has me confused and I wondered if you would please help me with answering a question.
    Expiration: I like closing the entire trade a little earlier, but how do I close the vertical spread and a Butterfly and get the most of the trade? Do I close the whole trade or just the part that has profit and leave the negative to expire worthless? I can’t seem to get this close-the-entire-trade out thing right.
    Thank you.

  2. Danielle – great series of posts. You have several bullish trades using our stacked butterfly approach but I have not seen any posts on bearish trades using this approach. Do you prefer simple puts or maybe diagonals since this are rising IV trades that might hurt a butterfly design?


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