Choosing an Earnings Strategy

Key Concepts

• Earnings Announcements: Quarterly financial reports released by publicly traded companies.
• Binary Events: Events with a high probability of a significant outcome in one of two directions (e.g., stock price moving up or down).
• High Volatility: Periods of rapid and significant price fluctuations in the market.
• Defined Risk Strategies: Trading strategies where the maximum potential loss is known in advance (e.g., vertical spreads, iron condors).
• Undefined Risk Strategies: Trading strategies where the maximum potential loss is theoretically unlimited (e.g., short puts, short strangles).
• Front Week Expiration: Options contracts that expire within the current trading week, typically with only a few days left until expiration.
• Regular Cycle Expiration (45-day window): Options contracts with a longer expiration period, generally around 45 days.
• Expected Move: The anticipated price range a stock might move within a specific timeframe, often based on options pricing.
• Butterfly Spread: An options strategy that involves buying and selling options at different strike prices to profit from low volatility.
• Gamma: A Greek letter representing the rate of change of an option's delta with respect to a $1 change in the underlying asset's price. Gamma is highest for at-the-money options close to expiration.

Choosing an Earnings Strategy

The video discusses the rationale behind trading earnings announcements and provides guidance on selecting appropriate strategies, particularly for new traders.

Why Trade Earnings?

Earnings announcements are favored by traders for three primary reasons:

1. Quarterly Occurrences: They happen predictably every quarter (typically January, April, July, October), providing consistent trading opportunities. These "heavy months" usually see a concentration of earnings reports within a two to three-week window.
2. Binary Events: By their nature, earnings announcements release a significant amount of new information in a short period, setting the stage for potentially explosive price movements in either direction. Other examples of binary events include FOMC meetings and jobs reports.
3. High Volatility Events: Leading up to an earnings release, there is a reliable increase in implied volatility as traders anticipate the stock's price movement and the release of financial data (revenues, earnings, guidance, new developments). This creates a high volatility environment that is attractive to traders who specialize in selling premium.

The "Gotcha" of Earnings

While high volatility is a "gimme," the "gotcha" is the inherent risk. Traders must be acutely aware that earnings can lead to significant, potentially unfavorable, price swings. A wrong directional bet can result in substantial losses if the stock moves sharply against the trader's position.

Strategy Selection: Defined vs. Undefined Risk

The choice between defined and undefined risk strategies is crucial, especially for new traders.

• Defined Risk Strategies: These include vertical spreads, iron condors, and calendar/diagonal spreads. The maximum loss is capped.
• Undefined Risk Strategies: These include short puts, short strangles, and ratio spreads. The potential loss is theoretically unlimited.

Recommendation for New Traders: Jim Schulz strongly advises new traders to exclusively use defined risk strategies when starting out. This approach allows them to gain experience without the risk of unlimited losses.

Taking Directional Shots

• Short Vertical Spreads: Generally considered higher probability directional plays.
• Long Vertical Spreads (at-the-money): Essentially a 50/50 shot, offering a directional bet with a balanced probability.
• Butterflies: A strategy often used by the speaker, fitting into the directional category.

Expiration Cycle Choice: Front Week vs. Regular Cycle

The decision between using the "front week" (expiring within days) or a "regular cycle" (e.g., 45 days) depends on the desired speed of results and risk tolerance.

• Front Week:

  • Pros: Results materialize very quickly ("instant pain or instant gain"). If the trade is correct, profits are realized rapidly.
  • Cons: If the trade is wrong, losses can be significant and immediate. Engaging with options Greeks (especially gamma) at their highest point can amplify losses.
  • Suitability: Best for defined risk strategies, especially directional ones like vertical spreads or butterflies, when quick results are desired.

• Regular Cycle (45-day window):

  • Pros: Allows for more gradual and methodical movement. If the trade is correct, profits are smaller but more manageable. If the trade is wrong, losses are also smaller.
  • Cons: Profits are not as immediate or as large as with the front week.
  • Suitability: Preferred for slowing down the trade and allowing for more gradual profit or loss realization.

Undefined Risk Strategies and Expiration Cycles

For undefined risk strategies (short puts, short strangles, ratio spreads, etc.), Jim Schulz strongly recommends using only the regular cycle (45-day window) and avoiding the front week.

Reasons for this recommendation:

1. Premium Collection: Selling premium in the front week yields significantly less extrinsic value compared to longer-dated options. Longer cycles offer more premium, increasing the break-even points and slowing down the impact of the Greeks.
2. Gamma Risk: In the front week, gamma is at its highest. This means that even small moves in the underlying stock can cause rapid and substantial changes in the option's delta, leading to potentially devastating losses in undefined risk positions with no safety net. The longer cycle mitigates this extreme gamma exposure.

Nvidia Earnings Trade Example

The speaker outlines his personal trading plan for Nvidia's upcoming earnings announcement, emphasizing that viewers should consider doing the opposite of his trade to potentially profit.

Speaker's Perspective on Nvidia: Jim Schulz expresses extreme bullishness on Nvidia, stating, "I just don't know how you can possibly look at Nvidia and be anything other than mega bullish." He believes Nvidia will not let the market down, especially given the current market downturn and fear index levels.

The Trade Plan:

• Strategy: Expected Move Butterfly.
• Timing: The trade will be executed in the final hour of the trading day before earnings.
• Width: A 12.5-point wide butterfly.
• Cost: Estimated to be around $2.50 to $3.00 per contract.
• Short Strike Placement: The short strike (or strikes, as there will be two) will be pinned directly at the expected move to the upside, indicating a bullish directional bet.
• Action for Viewers: Viewers are advised to fade this trade (i.e., do the opposite) if they are serious about making money.

Disclaimer: The speaker notes that this is a pre-recorded segment and the trade will be executed on the day following the recording. Viewers watching after the fact may have missed the opportunity to fade the trade.