Earnings: Setup & Risk Management

Here's a summary of the provided YouTube video transcript:

Key Concepts

• Microsized Earnings Approach: A strategy for trading around earnings events using smaller trade sizes.
• Volatility: The degree of variation of a trading price series over time. Earnings events typically increase volatility.
• Binary Events: Events with two possible outcomes, such as an earnings announcement.
• Engagement Trades: Short-term trades taken around specific events like earnings to increase trading frequency.
• Defined Risk: Trading strategies where the maximum potential loss is known and limited.
• Undefined Risk: Trading strategies where the maximum potential loss is theoretically unlimited.
• Iron Condor: A neutral options strategy that profits from low volatility, involving selling an out-of-the-money (OTM) call spread and an OTM put spread.
• Delta: A measure of an option's price sensitivity to a $1 change in the underlying asset's price.
• Put Skew: A market phenomenon where put options are relatively more expensive than call options, often seen in indices like the NASDAQ.
• Call Skew: A market phenomenon where call options are relatively more expensive than put options, often seen in tech stocks during earnings.
• Expected Move: The anticipated price range of an underlying asset after an event, such as earnings.

Earnings and Volatility

The transcript discusses the "microsized earnings approach" as earnings season approaches. Historically, earnings days are associated with significantly increased volatility. Data over 15 years shows that volatility, measured by the standard deviation of price from the average day to the earnings day, typically increases by about four times on an earnings day for the top five holdings of the QQQ ETF. This heightened volatility is characteristic of "binary events" in the market. Apple is highlighted as an example of a stock with very high volatility leading into earnings compared to the broader market.

Earnings as Engagement Trades

Earnings events are presented as opportunities for "engagement trades," which are described as non-standard, short-term trades. These differ from core strategies that might aim to profit from volatility contraction. Instead, earnings trades are binary events traded around for short-term gains. They can be structured with a directional component, such as diagonal spreads or calendar spreads, or with a focus on selling premium.

Defined Risk Strategies for Earnings

A key recommendation is to "define risk" when trading earnings. This approach can substantially reduce margin requirements and potential losses, while also enabling a higher number of occurrences and potentially high-probability trades. The idea is to put on trades with a small amount of risk, leading to either "instant pain or instant gain." The transcript advises keeping position sizes to 5% of net liquidating value or less for undefined risk trades.

Statistical Performance of Earnings Iron Condors

Statistically, earnings iron condors can be created with similar profit potential and win percentages as standard 45-day trades. For SPY, the win rate of an iron condor is approximately 73%. This win rate is comparable to trading short options with a 20 or 30 delta. However, it's crucial to acknowledge the "big tail risk" associated with earnings events, meaning a higher likelihood of maximum losses compared to typical 45-day trades.

Strategy Selection for Earnings

The choice of strategy for earnings trades depends on the trader's assumptions.

• Bullish Trades: Short puts or put spreads.
• Bearish Trades: Short calls or short call spreads.
• Neutral Delta Trades: Iron flies and iron condors.
• Diagonal Spreads and Calendar Spreads: Also viable options for earnings trades.

Example of a Microsized Earnings Trade Setup

A general setup for a "microsized" earnings trade is provided, suitable for smaller accounts. An example given is a $5 wide iron condor, where traders might collect 25% to 50% of the width, depending on the desired risk level. This is presented as a basic example for "Johnny sized" accounts.

Dynamic Iron Condors and Skew

The transcript explains how to structure risk-defined iron condors by utilizing the "natural skew" in the market and choosing strikes dynamically. This is termed a "dynamic iron condor." An example is given of selling a 20 delta put and buying a 10 delta call to define risk, creating a delta-neutral trade. A specific trade in the QQQ was mentioned, involving a 20-point wide put spread and a 10-point wide call spread.

The concept of skew is further elaborated:

• Put Skew: Common in the NASDAQ and ETFs, where puts are relatively more expensive.
• Call Skew: Often observed in tech names during earnings, where calls are relatively more expensive.

Traders can adjust their dynamic iron condors to play into these skews or to achieve true delta neutrality by using the same delta for both short and long options.

Trade Execution Example and Earnings Indicators

A specific trade example is mentioned: a NASDAQ futures trade at 24,000, with an entry at 93. The transcript also explains how to identify earnings on a trade platform. The purple line indicates upcoming earnings, and a bell icon signifies whether the earnings announcement is before or after the market open. An arrow next to the bell indicates the timing: after the bell if pointing right, before the bell if pointing left.

Expected Move and Strategy Choice

The "expected move" is a critical factor in dictating strategy.

• Higher/Wider Expected Moves: Indicate higher volatility and juicier premiums, making defined risk strategies attractive.
• Lower Expected Moves: If a trader is hesitant about risk, they might avoid underlyings with lower expected moves or choose a different strategy.

Conclusion and Key Takeaways

The main takeaways from the transcript are:

• Earnings events provide opportunities to increase the "number of occurrences" through "engagement trades."
• These earnings trades should be smaller in size compared to regular trades (e.g., two contracts instead of ten).
• Earnings events often result in "instant pain or instant gain," especially when using shorter-duration options.
• The primary benefit of the microsized earnings approach is to leverage increased volatility for short-term trading opportunities while managing risk effectively.