Earnings Central

• Posted by Adam Warner
• on October 20th, 2009

So I have (hopefully) made it clear I way prefer shorting to buying options premium ahead of an earnings report. You win more often than you lose, but the key point is that the losses can dwarf the winners in magnitude, so you need to manage the trade.

Tyler from Know Your Options had a great write up on AAPL options pre-earnings, which basicaly serves as a good primer for any stock. Especially this.

But here’s the rub. The times when a stock ends up gapping more than expected can be quite painful for vol sellers. Who cares if I win 5 out of 7 short volatility plays if on the 2 losers I get steamrolled? In the end I believe this exercise simply reiterates the importance of sound risk management. Though it doesn’t take a genius to tell you there’s an edge in favor of vol sellers into earnings, it does require at least a savvy trader to play earnings profitably over the long run. Make sure you exercise sound risk management rules like diversification and proper position sizing.

That 5 of 7 was just for AAPL on their last 7 reports, but those numbers sound realistic for most any name. In fact, if volatility bidups are “fair”, the stock should open within a range implied by them about 68% of the time. And the losses should beat the winners roughly such that the expected gain of net-buying should equal the expected gain of net-selliing over time.

But it doesn’t mean every single report, or every single cycle, is in perfect equilibrium. Bidups may be too high early, or too low early, and adjust over the course of a cycle.

The net of this go around looks like a whole lotta nothing. Volatiltiy in general is very low (at least relative to the past year) and bidups are rather muted as well.

And as to what Tyler says at the end, totally agree. Been leaning towards just selling spreads when I sell pre-earnings. Mostly because of that low volatility I just mentioned. Straight premium sales are fine though, I’d just make sure to stay disciplined and take the hit when it goes against you. You don’t see too many overnight blasts get reversed in the morning.

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