Calendars Held Over Earnings


Posted on Wednesday, May 3, 2017 at 1:54 PM

Continuing on from a couple of weeks ago when we talked about an option strategy that pertains to earnings, here is another strategy option traders can consider. In this blog, we will talk about a trade that can profit when held over the announcement. Although many option traders will naturally steer away from earnings because of the volatile nature which is usually not a bad thing, the risk/reward of this option spread can be very tempting. The strategy is a long calendar and it is pretty simple to implement. First let’s take a look at what a calendar is below.

A long calendar is selling an option and buying a longer-term option with the same strike. Generally, all calls or all puts are used. A calendar is a time spread because it benefits from the passing of time. The short option will have a bigger positive theta than the long option which will have a smaller negative theta. The maximum profit is realized if the stock closes right at the strike price of the short expiration. That option expires worthless and the long at-the-money (ATM) option will have time premium left. The max profit and the break evens are all hypothetical because there are two different expirations. Using the P&L (profit and loss) diagrams that your broker probably provides, is the best way to estimate them.

The key component that can enhance potential profits is an implied volatility skew. An option trader prefers to sell higher IV and buy lower IV. For the long calendar, a higher IV is naturally preferred on the short option with a lower IV compared to the short strike on the long farther out expiring option. Many times, this can be difficult to find and we talk about this scenario all the time in Group Coaching. But when there is an earnings report that is scheduled to be released, the IV for the options that expire closest to the report will have a higher IV than expirations that take place even further out. In essence, it is a perfect opportunity for an IV skew!

Let’s take a look at a recent example. Advanced Micro Devices (AMD) that was scheduled to release its earnings on a recent Monday after the close. Calendars can be used for neutral and directional outlooks. Remember an option trader wants to set-up the calendar where he thinks the stock will be trading at the short expiration. Let’s assume a neutral forecast was expected after the announcement. Taking a look at the chart below, A trader can sell the 13.5 strike for Friday’s expiration and buy the same strike for the following expiration. Note that the short expiration has an IV over 107% and the long expiration is just below 77%. That means he or she would be selling more expensive premium than he or she would be buying.

Of course, the stock needs to cooperate and in this case, not move much after the announcement. The IV for the short and long options should drop after the announcement and that is where the option trader realizes his or her potential profit. The short option should decrease more than the long option percentage-wise which should increase the value of the spread if the underlying trades relatively close to the short strikes the next day. Although maximum profit is potentially earned at the short expiration, with an earnings calendar, it may be worth exiting some if not all of the position the morning after the announcement.

Long calendars held over earnings can be relatively low risk high reward trades. Like most trading, there is always an element of luck involved. You want the stock to move or stay near your strikes and you just don’t know exactly what will happen despite having a P&L diagram. As I like to say about earnings calendars, sometimes I am surprised I made money and sometimes I am surprised I lost money. Good luck!

John Kmiecik

Senior Options Instructor

MarketTaker Mentoring Inc.

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