How to Play Earnings

It’s hard to believe that Private Trader has been around for more than a decade. The first post, on November 4, 2009, was a watchlist of stocks, and the next day, I wrote up my trade in one of them, a bull put spread on CSCO.

I had dabbled in active management of trades since the mid-1980s, but in 2009 I started to get very serious about trading after my contract job managing projects disappeared at the start of the Great Recessions. There were no jobs, and trading was one way to help put rice in the rice cooker.

Long-term readers will recall that over those years, from time to time, I’d try out various ways of trading earnings announcements using options. It was an appealing idea. Most of the options strategies I use — spreads and iron condors entered 45 days out from expiration — stay on the books for nearly a month before I exit. Earnings plays, at their best, are two-day positions, in before the announcement and out at first opportunity afterward. It keeps my capital churning, and that’s ideally what makes profits.

No earnings play method that I’ve tried so far has really worked out to my satisfaction. So, one by one, I’d abandon them and mope along with my monthly spreads and iron condors, many of them profitable, but the pace of trading left me with a lot of idle time.

So my interest was piqued when Nick Battista, of the TastyTrade team, posted a graphic on Twitter showing the expected moves of three stocks after their earnings announcements that same day. Curious, I asked him what he had based the expected moves on, and he was generous enough to reply.

An aside. I’ve followed TastyTrade, an online network devoted to analyzing trading strategies and teaching people about options, since its inception in 2011, and even before that, I had traveled from Portland, Oregon to Chicago to attend a presentation and training session conducted by Tom Sosnoff, a veteran of the Chicago options exchange and head of the team that designed ThinkOrSwim, at one time the best trading platform for options (and it’s still very, very good).

I’ve learned more about trading options from Tom and TastyTrade than from all of my efforts before they hit the ‘net. They don’t know me from Adam (I did meet Sosnoff, briefly, long ago), but I consider them to be my mentors.

So, back to earnings plays. Nick in our Twitter exchange briefly described his use of options pricing to calculate the expected move.

After our brief exchange, I immediately rushed to the TastyTrade site to search out more details, and found them in an episode dating back to last February, a 10-minute airing of “Options Jive” in which Tom Sosnoff and Tony Battista talked about the details of calculating expected move.

The method works by taking the value of three positions and weighting them according to their distance from the at-the-money (ATM) mark.

  1. Using the options closest to expiration…
  2. take the price of an ATM short straddle and multiply it by 60% (0.6)…
  3. take the price of strangle one strike price away from ATM, and multiply it by 30% (0.3)…
  4. and take the price of a strange two strikes away from ATM, and multiply it by 10% (0.1).
  5. The expected move is the average of the weighted prices — add them together and divide by 3.
  6. Note that the expected move doesn’t anticipate the direction of the move — could be up, could be down.
  7. Trades are best placed at a time as close to the earnings announcement as is feasible.

Expiration dates most of the time won’t match the date of entry into an earnings play. Nick Battista’s practice is to discount the expected move by 5% times the number of days, minus one, remaining until expiration, and that’s a practice that I shall adopt.

Sosnoff in the “Options Jive” video says that the method works out 68% of the time. The reality of trading is that no estimate of outcomes is 100%, and being right 68% of the time, I’ve found, gives me the edge I need to stay profitable.

TastyTrade’s affiliated trading platform, TastyWorks, displays the expected move based on this method, absent the time discount, in the corner of each options grid.

So how should I use this? As regular readers know, I don’t trade without rules. I post them in the “Trading Rules” page linked to on the menu bar at the top of each page.

Here’s my first attempt at rules for how to trade expected earnings.

  1. Enter a position on the final trading day before the earnings announcement. (I need to determine how much price change there is prior to the day before.)
  2. Select highly liquid stocks with options having an implied volatility rank of 30% or higher.
  3. In selecting the options expiration date, it’s important to weigh the price received for the options vs. the speed of time decay, which helps the value. Also, monthly options have narrower bid/ask spreads than do the weeklies. (I don’t have a firm rule on how far out from expirations the options should be. For normal spreads, the optimal buying period is 45 days from expiration.)
  4. Optionally, pick a direction for the expected move. There are many ways to do this. I use Elliott wave analysis, and sometimes check out the Zacks Rank and Expected Surprise Prediction percentage.
  5. Directional strategies: For lower risk (and lower returns), short bull put spreads if a rise is expected, short bear call spreads if a fall is expected. For higher risk (and higher returns), short puts if a rise is expected, short calls if a fall is expected.
  6. If no direction is picked, use a non-directional strategy: For lower risk, iron condors. For higher risk, strangles.
  7. The short strikes for each strategy should be far enough out of the money to enclose the expected move.
  8. Exit at the earliest profitable opportunity.

And that’s it. A trade that’s over in two days or so, backed by a statistically sound rationale.

It’s earnings season, and I’ll be looking at LEN and JBL on Wednesday, and FDX and DRI on Thursday, and as I do with my slower options strategies, I shall post about the trades on PrivateTrader.

By Tim Bovee, Portland, Oregon, December 10, 2021


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.

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