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Trading options for income: Earnings and expected move

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In our quest to understand trading options for income, we often consider selling an Iron Condor or Strangle just before earnings announcement, when the option chain IV (implied volatility) is at its highest.

A short Iron Condor is a defined risk option strategy composed of the following: an OTM (out of the money) Put credit spread and an OTM Call credit spread, both within the same option chain. A short Strangle is an undefined risk option strategy composed of the following: an OTM short Put and an OTM short Call, both within the same option chain.

To determine the efficiency of the option chain when the underlying stock is about to report earnings, Tasty Trade tested the expected move, or 1 SD (standard deviation), on 19 different underlyings representing 454 earnings cycles (over a period of 6 years). Two data items were checked: if the underlying opened within the expected move (1 SD, 68 percent) after the announcement; and if the underlying expired within the expected move (1 SD).

The results: the underlying opened within the expected move 83 percent of the time; the underlying closed within the expected move 77 percent of the time.

Based on the Results Table, 6 underlyings expired within the expected move over 85 percent of the time: AAPL 88%; C 90%; COST 100%; SBUX 88%; X 95%; and YHOO 89%.

In conclusion, if you are going take advantage of high option chain IV just prior to the earnings announcement, underlyings that have results over 80 percent of expiring within a 1 SD EM (expected move) will likely require the use of a Strangle (and not an Iron Condor). This is due to the low price of the underlying (except AAPL) and low volume of the options themselves. Only AAPL has both a high price and a very liquid option chain, which lends itself well to the use of a wide Iron Condor.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.



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