My sole strategy the last few months has been
- wide iron condors (deltas of 20 or less for the two short legs)
- and high implied volatility ranks
- entered with about 45 days until expiration
- and managed at 21 days before expiration
- while avoiding earnings announcements.
Such a setup generally gives an 80%+ chance of earnings profit, always a good thing. But it limits the choice pretty much to exchange-traded funds. Because the dirty little of implied volatility is that it goes up as earning approach, and goes down quite suddenly once the earnings announcement has been made.
I think the term of art for such a situation is “stuck between a rock and hard place.” For the most part, I can’t find high implied volatility without earnings, and the surprises that come with earnings can destroy the advantage I get from trading wide and safe.
So what’s a trader to do? Here’s an approach I shall be trying.
The iron fly (a term coined by the team at the options education site TastyTrade, is the narrowest of iron condors, with the two short legs having the same strike price. Whereas the wide iron condors I trade generally will have a 4:1 risk/reward ratio, an iron fly can be set up so as to reverse that to a 1:4 risk/reward ratio.
An iron fly strategy for earnings would to trade
- iron flys (deltas as close to 50 as possible on each of the two legs, consistent with their having identical strike prices)
- and high implied volatility ranks
- entered on the closest trading day to the earnings announcement
- with about two days before expiration
- and managed immediately after the earnings announcement or allowed to expire.
So for example, IBM publishes earnings on July 17 after the closing bell, meaning I would enter my trade on that day. The IV Rank (today) is 55.3%, which is quite high. The setup (if today were the day) is to trade options expiring July 19, short the $141 calls and puts, with the long wings $4 wide on each.
With that setup, the most I can lose per contract is $91 ($0.91 per contract/share), and I can potentially gain $324 per contract ($3.24 per contract/share). Thats a 1:3.6 risk/reward ratio.
Narrow the wings to $3 wide and the maximum is $259 per contract vs. a maximum loss of $41 (risk/reward = 1:6.3).
I’ll know before the next trading day what the outcome is, and I can decide whether to get out of a losing position a day before expiration, or let a winning position expire.
Earnings are devilishly difficult to predict. The iron fly strategy lessens the cost of being wrong to a trivial amount, and that’s what makes it attractive.
I’m still thinking about how the iron fly strategy might work with my wide iron condor strategy in order to allow me to hold wide iron condors through earnings announcements. Certainly a successful iron fly would enhance earnings from a wide iron condor. If the wide position has moved close to one of the wings, the iron fly could provide a hedge. Maybe. I still need to work that out, and I’ll post an update when I have.
By Tim Bovee, Portland, Oregon, July 10, 2019
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.
All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
Based on a work at www.timbovee.com.