Earnings season is once again upon us.
Last week the big banks kicked off the season, and this week offers some additional market stalwarts like Johnson & Johnson (JNJ), AT&T (T), Verizon (VZ), American Express (AXP) and a few notable others.
I’ll be focusing my efforts next week on the aforementioned group of stocks, but I can’t help to look at what the “notable others” in the group are offering, namely Tesla (TSLA) and Netflix (NFLX).
Tesla is due to announce after the closing bell Wednesday.
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So let’s go through the exercise of looking at a potential trade and its associated mechanics to see if TSLA is offering a decent trading opportunity this time around.
Here is an early look at a potential earnings trade for next week. Hopefully this helps a few of you, particularly those who are new to earnings trades, with the mechanics of a trade.
Iron Condor Earnings Trade in Tesla (TSLA)
Again, Tesla (TSLA) is due to announce after the closing bell Wednesday. So, let’s take a look at the expiration cycle of July 29, 2022.
The stock is currently trading for 720.39.
The next item is to look at the expected move in TSLA for the expiration cycle that I’m interested in.
The expected move or expected range over the next 14 days can be seen in the pale, orange-colored bar below. The expected move is from 645 to roughly 795, for a range of $150.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 645 to 795.
This is my preference most of the time when using iron condors.
If we look at the call side of TSLA for the July 29, 2022, expiration, we can see that the 830 call strike offers an 88.79% probability of success. So, I’m going to sell the short call at the 830 strike and define my risk with the 835 call strike. By choosing the 835 call strike to define my risk, I know that there is less than a 11% chance that I will take a max loss on the trade.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 645. The 600 put strike, with an 86.40% probability of success, works as our short put strike. I’m going to define my risk by choosing the 595 put strike with an 87.33% probability of success. This means we have less than a 13% chance of taking a max loss on the downside.
We can create a trade with a nice probability of success if TSLA stays between our 230-point range, or between the 830 call strike and the 600 put strike. Our probability of success on the trade is 88.79% on the upside and 86.40% on the downside.
With TSLA currently trading for roughly 720, we have a cushion of $110 on the upside and $120 on the downside, or 15.3% and 16.7%, respectively.
Is the cushion enough? How would it compare with other earnings reactions?
At first glance, the range looks plenty wide, certainly wide enough to warrant another look as we get closer to TSLA’s announcement.
Here is a potential trade based on what we’ve discussed so far:
Sell to open TSLA July 29, 2022, 830 calls
Buy to open TSLA July 29, 2022, 835 calls
Sell to open TSLA July 29, 2022, 600 puts
Buy to open TSLA July 29, 2022, 595 puts for roughly $1.05 or $1.05 per iron condor
Our potential return on the trade: 26.6%
Our margin requirement is $395 per iron condor.
Again, the goal of selling the TSLA iron condor is to have the underlying stock stay below the 830 call strike and above the 600 put strike immediately after TSLA earnings are announced.
Here are the parameters for this trade:
- The probability of success – 88.79% (call side) and 86.40% (put side)
- The maximum return on the trade is the credit of $1.05, or $105 per iron condor
- Breakeven level: 831.05 – 589.95
- The maximum loss on the trade is $395 per iron condor. Remember, we always adjust if necessary and always stick to our stop-loss guidelines. Position size, as always, is key.
One other important note: I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So premium could be an issue at the time of the trade. But I like to see where potential trades stand the week to a few days prior, so I have a good understanding of what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list within my Earnings Trader service.
Andy Crowder is a professional options trader, researcher and Chief Analyst of Cabot Options Institute. Formerly with Oppenheimer & Co. in New York, Andy has leveraged his investment experience to develop his statistically based options trading strategy which applies probability theory to option valuations in order to execute risk-controlled trades. This proprietary strategy has been refined through two decades of research and real-world experience and has been featured in the Wall Street Journal, Seeking Alpha, and numerous other financial publications.