In our quest to understand trading options for income, we often consider strategies for playing post-earnings when we feel the underlying equity will likely consolidate (or unlikely to move much). There are two strategies often considered for post-earnings: the ATM Butterfly, and the ATM Calendar.
ATM (at the money) refers to the closest strike to the current price of the underlying equity. For example, if the equity is Apple and its current price after earnings announcement is $501, then the closest option strike is $500.
A Butterfly strategy is comprised of two spreads (one credit and one debit; either Put or Call) in which the short options of each are the same strike. Using the previous Apple example, an ATM Butterfly would be: Call credit spread 500/505 and Call debit spread 500/495 (or, Put debit spread 500/505 and Put credit spread 500/495), where the short strikes are both at $500.
A Calendar strategy is comprised of two options at the same strike, but the short option is located in an option chain with a shorter DTE (days to expiration) than the long option. Using the previous Apple example, an ATM Calendar would be: sell MAR 500 Call and buy APR 500 Call (or, sell MAR 500 Put and buy APR 500 Put).
Both the ATM Butterfly and the ATM Calendar will benefit if the underlying equity does not move much in price through expiration. The ATM Butterfly benefits from a declining IV (implied volatility); the ATM Calendar benefits from an increasing IV. And both strategies will have positive Theta; meaning that time decay is a benefit.
Tasty Trade did a test comparing the two strategies for the following equities over 12 post-earnings, or a 3-year period: GMCR, NFLX, GOOG, GS, AMZN, and AAPL. The test criteria was as follows: after earnings announcement at the close, enter the strategy using the nearest monthly expiration. For the ATM Butterfly, each leg will be $5 wide; for the ATM Calendar, the long option position will be in the next Monthly (the short option being in the current Monthly).
The results: First, both strategies lost money, with the ATM Butterfly losing the least (half the ATM Calendar); this is likely due to the lower average cost ($0.62 vs. $4.43) of the Butterfly.
Second, the average number of days after earnings was 24, and during that period price moved an average of 8.84 percent; this indicates that shorter time-frames (or DTE) would reduce the movement. Instead of using the current Monthly, we could use the current Weekly. Comparing an Apple Monthly (24 DTE) vs. Weekly (3 DTE) Butterfly the day after earnings (on January 28, 2014): Price $20 (M) vs. $72.50 (W); Theta $0.88 (M) vs. $8.55 (W); while the cost for the Weekly is 3.6x the Monthly, the Theta for the Weekly is over 9.7x larger than the Monthly. A shorter DTE for the ATM Butterfly would likely improve the P&L: the Apple Weekly lost -$12.50 vs. -$20 for the Monthly.
And third, the drop in IV Ranking pre-earnings (52) vs. post-earnings (24) indicates that the better strategy would be to sell premium just prior to earnings to capture the collapse in IV. A strategy to consider is a wide Iron Condor (or Strangle) that benefits from a reduction in IV.
In conclusion, both the ATM Butterfly and the ATM Calendar are not appropriate strategies post-earnings since they both lost money. While price movements of the underlying might be in a narrow range post-earnings, the longer the time-frame (or DTE) the more likely the underlying price will start to move; therefore, the Butterfly strategy (which can have the shortest DTE vs. the Calendar) would likely improve its P&L with shorter time-frames (Weekly vs. Monthly).
If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.