Weekly Options Windfall
In our last post (you can see it by clicking here: weekly options windfall ) we went over a weekly options / monthly options trading set up for a unique way to play a ‘pre earnings announcement’ calendar spread trade that can create great monthly / weekly options windfall profits.
In this post we’ll continue with the strategy, covering a bit more about the management and exit plan for the trade, as well as the risks that are involved with making this options trading play.
First, a quick re-cap of this options strategy:
This is a short term options trading strategy that could be played with either weekly option or monthly options. I would consider this more of a speculative trade than a consistent bread and butter income strategy – but, it could be played over and over again once the trader gets familiar with it and as long as they are able to find a steady supply of stocks that fit the criteria.
This is a pre earnings play. We look for a stock that is set to announce earnings right after one options expiration cycle ends – for example the week AFTER regular monthly options expiration.
With this trade we are trying to take advantage of the volatility skew that typically occurs when there is a news type event or an upcoming earnings meeting. Usually when there is an earnings meeting / announcement the volatility will rise in the options. This rising volatility will pump up the cost / value of the options and hold them steady until the earnings are actually released. Once the earnings announcement occurs, usually the volatility will immediately drop back down – dropping the cost / value of the options with it.
So in order to use this to my advantage, what I will do is first look for a stock that will be announcing earnings a week or less after one options expiration cycle ends. I will then purchase an option at or a near as I can get to the money – in the month that the earnings announcement will occur.
Then I will SELL an option at the same strike in the front month – the month where there is an options expiration cycle that ends BEFORE the earnings announcement.
Here is an example:
Let’s say that the current date is January 11 and that stock XYZ will have an earnings announcement meeting on Febuary 25.
The January options will be expiring on January 18.
Here’s what I would do. I would purchase the Feb option that is closest to the money. Then I would sell the Jan option at the same strike price – creating a calendar spread trade.
Since the January options will be expiring (and will no longer exist) by the time that the Feb earnings announcement occurs – those options will most likely decay at a normal rate and volatility will really not be an issue – due to the fact that the Feb earnings announcement will have no effect on those options since they will not be around at the time of the earnings announcement.
On the other hand, the Feb options that we purchased WILL be in play during the earnings announcement – and they most certainly WILL be effected by the upcoming earnings announcement. As the earnings date approaches, the volatility will very likely continue to rise and boost the cost / value of those options.
So, in the overall calendar trade, the front month options that we sold would decay at a normal rate without the earnings volatility really effecting them. The back month options that we purchased would likely RISE IN VALUE – or at least HOLD their value – at least until announcement day.
The difference – the SPREAD – is our profit – and due to the fact that the front month options are decaying while the back month options could decay very little – or actually INCREASE in value – this could be a HUGE return on investment – especially when you take into account that this is a very short term trade – most likely seven to ten days long.
Managing the Trade and Exiting
Now that we have the set up and entry, let’s look real quickly at how I would manage and get out of the trade.
Again, this is a very short term trade. Seven to ten days long. Of course, no matter what I would get out of the trade before the front month options expire or at the latest on expiration day (the day that the Jan options expire in the example above)
In this trade, other than volatility risk – there is price risk. I could experience a loss if the underlying made too big of a move before I realized my profit target – or the Jan options expire.
So I will set a both a profit target and a ‘max pain – max loss’ point at the time of entry. Personally I would set my profit target at ten percent – and I would set my ‘max pain – max loss’ point at the same – ten percent. So, once I hit a ten percent profit in the trade I would take it off. Or, on the other hand, if I hit a ten percent loss in the trade before reaching my profit target – I would just take it off for a loss. I want to keep these two targets the same.
While it’s important to remember that there is always risk in trading – this options trading strategy can stack a lot of odds in the traders favor and can potentially generate big profits – and they can be generated very quickly due to all these pieces working together. It’s just a matter of finding the right ‘pre earnings announcement’ set up and then of course correctly managing the trade.
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