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Trading options for income: Two earnings trades

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In our quest to understand trading options for income, we often consider strategies specific to earnings season, when companies release their earnings reports. A bullish strategy (Sunnyside Up) is compared to a bearish strategy (Over Easy).

The bullish Sunnyside Up strategy consists of an ATM (at the money) Call debit spread (bull Call spread) and a 1 SD (standard deviation) OTM (out of the money) short Call (which finances the debit spread). The short Call should bring in enough premium to result in a net credit for the strategy. This is an undefined risk strategy requiring 3 options for a 1 lot (the Call debit spread plus the short Call).

An ATM debit spread consists of buying one ITM option (1 strike in) while selling one OTM option (1 strike out).

The bearish Over Easy strategy consists of an ATM Put debit spread (bear Put spread) and a 1 SD OTM short Put. The short Put should bring in enough premium to result in a net credit for the strategy. This is an undefined risk strategy requiring 3 options for a 1 lot (the Put debit spread plus the short Put).

Tasty Trade recently tested the two earnings strategies over 3 years using the following equities: AAPL, AMZN, CMG, GOOG, NFLX, and PCLN (total of 72 occurrences). The option chain closest to expiration was selected, and the OTM option chosen was the first resulting in a credit greater than the cost of the debit spread and greater than 84 percent OTM. The trade was closed the day after earnings announcement.

The results: the bullish Sunnyside Up strategy had a P&L of $7,642 (95% winners) while the bearish Over Easy P&L was -$3,419 (82% winners).

In conclusion, the Sunnyside Up strategy outperformed the Over Easy strategy despite being in a bull market; its P&L, average credit, and even the percent OTM of the naked option were better for the Sunnyside Up strategy. One consideration is that these are undefined risk strategies; hence the buying power reduction will be very high (for AAPL, typically 3x greater than a defined risk strategy using a $25 wide credit spread). In fact, on the last earnings play for AAPL (April 23, 2014), this strategy lost -$1,733.

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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