Earnings Is a 50/50 Coin Flip. Liz and Jenny Found a Way to Make It Pay 2.5x Either Way.

Key Concepts

• Earnings Diagonal: An options strategy involving the simultaneous sale of a near-term option (high implied volatility) and the purchase of a longer-term option (lower implied volatility).
• Expected Move: The price range a stock is statistically projected to move within by the market, based on current option premiums.
• Implied Volatility (IV): A metric representing the market's expectation of future price fluctuations; it typically spikes before earnings and "crushes" (drops) immediately after.
• Buying Power/Risk: The capital required to enter a trade; in this strategy, it is equivalent to the net debit paid.
• Recourse: A secondary strategy (e.g., selling a put or put spread) used to manage a trade if the stock moves against the initial directional assumption.

1. Market Context and Strategy Overview

The video highlights the "heart of earnings season," noting that earnings outcomes are essentially a "coin flip," with historical data showing a near 50/50 split between winners and losers. The traders emphasize that they do not attempt to predict the exact outcome but rather utilize a bullish diagonal strategy based on a directional assumption.

• The Trade: A bullish diagonal spread on Microsoft (MSFT) ahead of its earnings announcement.
• Philosophy: The traders, former floor traders with nearly 60 years of combined experience, stress that they are sharing their personal thought processes rather than providing financial advice for others to copy.

2. Methodology: The Earnings Diagonal

The traders utilize the Tasty Trade platform to identify the "expected move" and structure the trade to maximize profit potential while managing volatility risk.

Step-by-Step Execution:

1. Identify Expected Move: Use the platform’s visual tools (the "brown bar") to determine the market's expected price range for the earnings cycle. For MSFT, this was approximately $28.50.
2. Sell Near-Term Call: Sell a call option at the expected move (e.g., the 455 strike) in the 3-day cycle. This captures the high IV (97%) before it "crushes" post-earnings.
3. Buy Longer-Term Call: Buy an at-the-money call (e.g., the 425 strike) in a further-out cycle (e.g., 13 days).
4. Pricing Strategy: The goal is to pay approximately one-third of the width of the spread. In this case, a $30-wide spread was purchased for roughly $1,185.

3. Managing Volatility and Duration

A critical component of the trade is selecting the expiration date for the long leg to mitigate the impact of IV crush.

• IV Dynamics: The traders observe that IV is significantly higher in the 3-day cycle (97%) compared to the 13-day cycle (52%).
• The Trade-off: While moving the long leg further out in time increases the cost of the trade, it protects the long option from losing significant value due to the post-earnings IV collapse. The traders opted for the 13-day cycle to balance cost and volatility protection.

4. Risk and Profit Potential

• Risk: The maximum loss is limited to the debit paid ($1,185).
• Profit Potential: If the stock moves up to the expected move, the spread could be worth up to $3,000, offering a potential profit of approximately $2,700.
• Recourse: If the trade moves against them (the stock price drops), the traders plan to manage the position by selling a put or a put spread to offset losses.

5. Notable Quotes

• "It's a coin flip. Honestly, it's a coin flip." — On the predictability of stock performance post-earnings.
• "We're not saying we know Microsoft is going up, but we're putting on a bullish diagonal." — Clarifying that the trade is based on an assumption, not a prediction.
• "In the words of TFM, you got to risk it to get the biscuit." — Regarding the willingness to commit significant buying power to a high-reward earnings trade.

Synthesis

The earnings diagonal is presented as a calculated approach to volatility trading. By selling high-IV, short-term options and buying lower-IV, longer-term options, the traders aim to profit from the expected move while minimizing the negative impact of the post-earnings volatility crush. The strategy relies on a clear directional bias, a defined risk-to-reward ratio, and a contingency plan (recourse) should the market move against the initial position.