“Jacob, I played NKE earnings yesterday by buying the July 77.5 calls at 1.76. After the open, it popped to about 2.06 and then dropped down to 1.42—despite a pop of >2% in the stock. I assume the reason for the poor performance was volatility crush. So my question is how do you play earnings—selling puts if you are bullish? Thanks.”
My answer is that he is exactly right. His loss was a result of the volatility crush.
The metaphor I use over and over again is the hurricane. The hurricane/earnings event has passed, and so no one wants insurance/option volatility. The July volatility dropped from 28 to 16 on the open this morning, which significantly hurt the value of his calls.
So how do you play earnings with options? To be honest, it’s not easy. This trader had the direction of the stock right but still lost.
If I was bullish on a stock headed into earnings and was afraid of the volatility crush, I could execute the following trades:
Bull Call Spread: In this trade, you buy a call near at-the-money and sell a call further out-of-the-money. Because you sold an option as part of the structure, you reduced your volatility exposure.
Buy-Write: This is buying the stock and selling a call. The sale of the call makes you short volatility. However, this strategy limits your upside.
Naked Put Sale: This is a short volatility trade that profits as long as the stock stays above the strike of the put you sold. However, your profit is limited to the premium you received, and your downside is significant if the stock gets hit hard.
Bull Put Spread: This is the sale of a put closer to at-the-money and the purchase of a put farther out-of-the-money. This is a short volatility spread that profits if the stock stays above the strike of the put you sold. Your profit is limited to the premium received.
In conclusion, trading earnings is extremely treacherous. Typically, I like selling volatility into such events as the volatility crush can make those trades lucrative. On the other hand, when volatility is cheap enough heading into earnings, buying option volatility can be an absolute home run.
Here again is my options trading matrix for finding bullish/bearish or long/short volatility trades:
