Earnings season is the most hectic and volatile time of year for options, presenting a highly atypical sandbox for income traders who are incredibly skilled at navigating risk management and taking advantage of overbought premiums driven by increasing implied volatility (IV). Thousands of stocks report earnings every quarter, and option prices will be high beforehand when the news comes through, opening up successful trades for those who possess the talent to take advantage of the following volatility squeeze caused by news being released. The idea is that before earnings, market players drive option prices higher in hopes of a significant move but when the news comes out, IV intersects, and options fall despite the move. For option sellers in earnings, that volatility reduction is the first source of return. Among favorites are short straddles, short strangles, and iron condors, each of which is on those stocks known to exhibit subdued post-earnings action. The key is to match expected move experienced in the options with historical post-earnings reaction. When there is overestimated expected move, odds are in favor of premium sellers. An iron condor, shorting a call spread against an out-of-the-money put, makes money if the stock remains in a given range after earnings. A strangle or straddle short takes in more premium but has unlimited potential loss if the stock breaks out. Defined-risk spreads are used by traders to hedge risk or trade smaller sizes on very volatile stocks. Another strategy is selling after earnings, after the huge move and volatility have dissipated, writing calls or puts on a mean reversion move. In the stocks that gap down but are fundamentals-based healthy, selling cash-secured puts one day following earnings can earn good income. Calendar spreads may also be established prior to earnings, where the trader sells the nearby option and purchases a further-out one. This takes benefit of front-month IV collapse with still a profitable long-term position. Destructive behavior is also possible—directional earnings plays can be constructed with debit spreads if one is comfortable. As an example, an opening bull call spread can be established in a firm that will outperform earnings, with high reward potential and minimal risk. The application of defensive measures, such as the buying of cheap out-of-the-money options (long wings) or butterfly spreads, can also help minimize capital exposure. The best option strategy for income is most essential during earnings season. Never expose more than a part of the capital to any trade, and diversify by sectors and expiration dates to lower the effect of one event. Monitor implied volatility, skew, and sentiment to avoid crowd trades, and do not forget that even good earnings can result in a sell-off if hopes have been built too high. Earnings calendars, IV rank scanners, and ATR indicators are all resources to use in building context. It also pays to steer clear of low liquidity stocks with large bid-ask spreads that will make entry and exit of trades a nightmare. Lastly, track all earnings trades in a journal to improve your future edge—see what setups worked, what did not, and refine your criteria. Earnings season can be a surefire income generator if done sensibly. Focus on defined-risk positions, high-probability setups, and strong risk controls, and you’ll find that this volatile time becomes one of your most reliable windows for trading profits.
