Earnings season can be one of the most volatile and profitable times of the year for traders. But any experienced trader knows the unpredictability of earnings reports can open you up to more downside.
And since trading is all about controlling risk, many traders use options strategies to protect themselves if a trade goes the wrong way. Here are four popular options trading strategies that to use during earnings season.
The covered call strategy is one way to protect against potential earnings downside at the expense of sacrificing a bit of upside. If you anticipate an earnings beat coming, it’s only natural to buy shares ahead of the report. If you then turn around and sell out-of-the-money calls against the stock position, you can pocket the premium from selling the options, plus any potential upside between the stock’s current price and the strike. At the same time, if the stock falls on bad earnings, that option premium can help mitigate potential losses.
A married put strategy is similar to a covered call in that you can buy shares of the underlying stock, and then immediately turn around and buy out-of-the-money put options against those shares. For someone bullish on a stock ahead of earnings, a married put serves as a hedge against a large sell-off. Unlike a covered call, upside from a married put strategy is potentially unlimited. If the stock skyrockets, the value of the puts goes to zero, but the underlying stock position is the big winner. If the stock tanks, the value of the put can increase.
For traders who see a big earnings move coming, but aren’t quite sure whether that move will be up or down, a long straddle strategy may be the best bet. A long straddle involves buying calls and puts at the exact same price, typically near the stock’s current market price. In a long straddle, one of the positions is likely to decrease in value (though, if there is little to no movement in the stock price compared to the strike price, it is possible both positions will decrease in value), but the hope is that the stock will move so much in one direction that the winning position will more than make up the difference.
A less expensive way to play extreme earnings volatility is the long strangle strategy. A long strangle is similar to a long straddle, except the puts and calls are purchased at different strike prices. Typically, traders will purchase both options out-of-the-money, buying calls with strike prices above the market price and puts with strike prices below market price. The most you can lose is the cost of both the options. But like the long straddle, the hope is that large returns from either the calls or the puts will more than make up the difference.
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