In continuation of our series on trading earning with options, I’ll describe here the closure of an earnings trade on WSM.
I opened the WSM earning trade position yesterday with a short strangle, opened by selling options. I sold 27 strike September puts for $1.00 and sold 34 strike September calls for $0.70.
You can see a detailed analysis on this earnings trade that I published on Seeking Alpha.
This earnings trade was profitable, although it didn’t reach the maximal profit. I bought back the call options for $0.30 and the put options for $1.15. The net position credit of the short strangle initially at the open of the trade was $1.7 and I bought back the position for net $1.45, for a profit of $0.35 per option contract.
Volatility Pattern of WSM earnings trade
The reason that this earnings trade didn’t reach maximal profit is mainly because the volatility didn’t fall as much as expected. This is the main risk when trading earnings with options, since most of the profit comes from the volatility crash. The volatility of the September options series before earnings was 73%. I expected that this would fall by about 15% near the volatility of the next month options series. In practice the volatility only fell about 8%.
The other factor is the timing of the opening of this earnings trade. I opened the trade half an hour before the market close. Had I opened the position closer to the market close this trade would have been more profitable, since as it turned out volatility peaked sharply at the end of trade. In fact the call options could have been sold for around $0.80 and the put options for $1.10. This would have increased my profit to $0.45 per option contract.
This shows how critical it is to analyse the volatility patterns of individual stocks around the earnings announcement. Some stock options tend to experience a dip in volatility just before the close prior to earnings. As was the case with WSM, some stocks option sharply peak in volatility before the earnings announcement.
Timing the Closure of the Earnings Trade
When trading earnings announcements I decide the timing of the closure of the earnings trade before I open the position. I either close earnings trades at the open or at the close following the earnings announcement. This is based on historical analysis of the price movement. I choose whichever tends to move the least following the earning release.
In this case I planned to close the WSM earnings trade at the open. However immediately at the open the volatility was unchanged. From experience I know that volatility can initially remain elevated for the first few minutes of trade. The volatility crash came about 5 minutes after the open. I ended up taking a calculated risk and closing this trade half an hour after open. There was quite some risk involved because from the historical analysis WSM shows significant intraday movement after the earnings release.
This earnings trade was closed by buying back the individual components of the short strangle. I bought back the side that was most under threat. In this case since the WSM stock price dipped about 5% after the earnings release I bought back the put options initially. Immediately afterwards I bought back the call options and closed the trade.
Trading Earnings on WSM Summary
Trading Earnings can be extremely profitable. It allows option traders to profit within a wide margin of stock price movement. This is conditional on the option trader conducting a detailed analysis of the potential earnings trade.
I trade earnings for consistent income. It can be done. I’m still offering a free options trade alert service. You can sign up on the form at the bottom of the screen. It will become a paid service soon, so get in early.
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