Earnings Season is Upon Us … A First Look at a Potential Trade in JP Morgan (JPM)

This week is arguably the beginning of one of the most anticipated earnings seasons in market history.

The magic starts in earnest at the opening bell Wednesday when JP Morgan (JPM) and Delta Airlines (DAL)announce their earnings. And more companies follow suit as the week progresses with Morgan Stanley (MS), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS), Walgreens Boots Alliance (WBA) and a few notable others.

My approach to earnings is quite simple. I’m not trying to guess the direction of a stock after an announcement.

I’m simply taking a statistical approach.

Because every earnings announcement comes with uncertainty. And with that uncertainty comes heightened implied volatility as investors are either speculating to some degree or simply hedging their position. This is fact. Regardless, the increase in demand for options contracts leads to an increase in that underlying stock’s options prices, particularly during the week of the announcement.

I’m simply trying to find the best opportunities that the market has to offer during each earnings season and place statistically based trades on those that look the most promising.

The strategy is highly dependent on taking a quant-based approach. Again, focusing on the probabilities and allowing the law of large numbers to work its magic. But more importantly, a clear understanding of how to manage sequence risk when using a high-probability approach. I’ll be discussing all of this as we move through this earnings season.

One of Several Key Strategies to Trading Earnings

Iron condors are one, among several, of my go-to options strategies for trading around an earnings announcement.

The basic premise of the iron condor strategy is simple; choose a range that is typically outside of the expected move. Increasing the range will decrease your potential profits but will increase your probabilities of success.

As always, we only want to trade using highly liquid securities. I provide a screen of the most highly liquid stocks every week during earnings season which includes extensive research on each trade, including a screen for the best strategy to use.

For instance, take the heavily traded JP Morgan Chase (JPM). The company reports earnings before the opening bell next Wednesday and I’m curious how implied volatility looks for next week’s expiration cycle and the subsequent options prices.

The stock is currently trading for 170.15.

JPM-stock-chart-october-11-2021

As soon as earnings pass, implied volatility (IV) is crushed, so we want to take advantage of the short-term heightened levels. Again, inflated volatility is one of the key components to making this a successful, long-term strategy which is why IV rank and IV percentile are key screens in finding the best stocks to trade. (I post this on the most notable earnings announcements every Friday during every earnings season.)

An above-average to extremely high IV rank simply tells us that we can sell options for fair-to-highly-inflated prices. And as anyone who has sold something knows, your preference is to always sell your product(s) for inflated prices. Options are no different.

Next, I like to take a historical look at prior earnings announcements for the stock I’m interested in trading. Going all the way back to 2006, the average move in JPM is roughly 0.5% with anomalies sitting just beyond a 4% move. Knowing how a stock responds around earnings gives me insight into how to approach the trade, or to simply avoid a trade altogether.

JPM-earnings-announcements-historical-performance

Now we need to find the expected move or expected range for our chosen expiration cycle. In most cases, we use the expiration cycle that is one to nine days after the earnings announcement. We chose the expiration with four days left for our JPM trade.

The expected move for JPM is roughly $9. There are several trading platforms that offer the expected move, I have found that Tastyworks, at least from a visual standpoint, offers the best information on expected moves.

Because we know the expected move, we have the ability to choose strikes outside of that area.

First, I look at the call side of the iron condor, also known as a bear call spread. I want to find a short call strike with around an 80% probability of success.

The October 15, 2021 175 calls fit the bill. It has a delta of 0.17 and a probability of success of 83.62%. The probability that JPM will touch the 175 call strike at expiration is 33.20%.

october-expiration-cycle-calls-2021

Once I’ve chosen my bear call spread, I look towards the put side, for my bull put spread, with the same goal in mind: a probability of success around 80% or higher.

october-expiration-cycle-puts-2021

The October 15, 2021 162.5 strike put works. It has a probability of success around 88.08% and a delta of 0.11. The probability of touch stands at 23.54%.

So, my starting range is from 162.5 to 175. Obviously, I could have used different strikes, but this is the typical starting point for my iron condor trades around earnings. Once I know my potential return at around the 80% probability of success level, I can alter my range accordingly.

What’s the Return?

If I sell, say, the 162.5 /160 bull put spread and the 175/177.5 bear call spread simultaneously, thereby creating an iron condor position, I have the ability to bring in roughly $0.40, for a potential max return of 19.0%.

JPM-october-expiration-cycle-2021-iron-condor-trade

Because we are using 2.5 wide strikes (162.5/160 and 175/177.5), our risk is $2.10 per iron condor (width of spread strikes minus amount of premium received or $2.5 – $0.40).

With JPM trading at roughly 170.00, the breakeven levels are 175.40 to the upside and 162.10 to the downside. Again, the probability of success on the trade is a staggering 88.08% at the 162.5 put strike and 83.62% at the call strike. Our breakeven probabilities are even greater.

I like those odds.

Remember, it’s all about taking advantage of the law of large numbers and the IV crush that is inherent in each and every earnings trade. Once you move away from the mechanics of the trade, you’re allowing emotions to seep into your decision making, and that is what we all want to avoid.

Risk Management – Don’t Overlook the Importance of Position Size

Because we are making short-term trades based purely on binary events, risk management as seen through strict position size is essential for long-term success. In fact, since the trades have little to no duration, there is rarely time to adjust a trade, therefore, again, position size is key.

We know through extensive research that roughly 80% of the expected move around earnings is larger than the actual movement of the stock.

Remember, we are trading math here. It’s all about allowing the probabilities to work themselves out, knowing that if the law of large numbers play out, our wins should far outweigh our losses. So, keeping our risk at reasonable levels is of the utmost importance.

There is so much more minutiae that occurs during an earnings season play. As a result, I will be including several videos on the site and some live sessions to go over the different scenarios one might face when trading earnings.

As always, if you have any question, please do not hesitate to email me.

15 comments on “Earnings Season is Upon Us … A First Look at a Potential Trade in JP Morgan (JPM)

  1. Ahmad Mohammad on

    Hi Andy: I love and value greatly your daily emails about options trading based on math and the law of large numbers. This article is great and I actually sold 2 iron condors based on this article. However, my short positions were a little different from those in this article. My short put was $160 and short long was at $172.5 because yesterday, JPM was trading at about $165 or so. Now the earnings are out this morning, and the stock is trading around $161.50 or so. Looks like this trade is a winner and my premium of $35 per iron condor seems secure now. I sold only 2 iron condors and my profit will be about $70. No bad for a 4 days trade. I learnt that buying strangles and straddles were a way to benefit from earning announcemnts. I did not know that iron condors can also be profitable but with much less profit and much less capital at risk than either purchasing straddles and strangles. This is something I learned for the first time that one can also benef from selling iron condors around earnings announcements. Thanks you so much. I do always value your thoughts, your logic and your insights regarding option trades. Please do keep me among your favored students and If there is any way to benefit more personally from your insights and experience, please let me know. Thanks a lot. Ahmad

    Reply
    • Andy Crowder on

      Ahmad,

      Glad to hear you found the article helpful. Yes, it is always great to expand the toolbox of strategies. Iron condors are a great way to use a risk-defined options strategy around earnings. As for when to take the trade, it is ultimately up to you to decide what works best. I tend to go as close to the announcement as I can without sacrificing too much premium. I’ll be doing a video that goes through the details step-by-step and what to look for when placing a trade. Pros and cons, etc. Iron condors are risk-defined so they allow you to stay within your personal position-size parameters. Some of the premium is sacrificed due to the defined-risk nature of the trade, but it also means that far less capital is needed to place the trade. Typically, with iron condors the percentage returns are higher due to the return on capital. But you are never going to beat the high-probability nature of a short strangle. I hope this helps.

      Reply
  2. Ahmad Mohammad on

    Nice article with a timely good example of how selling high success probability iron condor trade can be done at earnings time. I used to think that only buying a straddle or strangle can be done to make a profit around earnings. So, your article taught me something new in my option trading tool box. I actually sold 2 iron condors yesterday based on this article but my short long and short puts were at different strikes, because JPM was trading near $165 yesterday (12 Oct.). My short put strike was at $160 and long strike was at $172.5 and I collected $35 for each iron condor – total of $70 for 2. Today the earnings were announced and they beat the expectations, but still, JPM is now trading around $161 – down $4 or so from yesterdays price. However, this trade is a winner and it expires on 15th – in two days time. I was always under the impressions that iron condor trades are done on stocks or ETFs that are not trending and trading within a well defined range. However, use of this trading method around earnings is an eye-opener for me and it is easy for me to apply it at times near earning announcements. My question is when should we undertake this trade? One week earlier than announment date or even earlier and how these iron condor trades differ from buying strangles and straddles before earnings in respect of risk, reward and probability of success.
    I woud greatly appreciate your responses.

    I am already a faithful student of yours and I hope to benefit much more from your anayses, insights and experience in profitable options trading as a small self-directed options trader. Thanks – Ahmad

    Reply
    • Andy Crowder on

      Ahmad,

      Glad to hear you found the article helpful. Yes, it is always great to expand the toolbox of strategies. Iron condors are a great way to use a risk-defined options strategy around earnings. As for when to take the trade, it is ultimately up to you to decide what works best. I tend to go as close to the announcement as I can without sacrificing too much premium. I’ll be doing a video that goes through the details step-by-step and what to look for when placing a trade. Pros and cons, etc. Iron condors are risk-defined so they allow you to stay within your personal position-size parameters. Some of the premium is sacrificed due to the defined-risk nature of the trade, but it also means that far less capital is needed to place the trade. Typically, with iron condors the percentage returns are higher due to the return on capital. But you are never going to beat the high-probability nature of a short strangle. I hope this helps.

      Reply
  3. Ahmad Mohammad on

    Thanks Andy: I do greatly appreciate your responses to my questions. I am looking forward to an article on how short strangle trades around earning announcements can be helpful and to how to trade these strangle trades.
    I have another question about iron condor trades. Most often the call side of the iron condor breaches the strike price and results in losses very quickly. What are the adjustments if the call side results in losses?

    Is it best to take a loss immediately after the strike price breach occurs or to wait, or is any other adjustment that canbe made to prevent losses from this long leg of the trade? Are there any adjustments that can be made by rolling over the long call side to a highter strike up or any upward adjustments to the profitable short put side?

    Will greatly appreciate your thoughts. Thanks – Ahmad

    Reply
    • Andy Crowder on

      No problem.If you are using high-probability bear call spreads you should not be seeing the spread move up in value quickly if it moves against to you. The reason is because the overall delta of the spread is small. That’s the beauty of high-probability credit spreads, you can be completely wrong on your assumption and still make a profit on the trade. As for stop-losses, I typically go 1 to 2 times the original credit.

      The goal is to be proactive, so when the delta hits 0.30 to 0.35, typically the move is to roll the untested side first. Some roll the tested side, but all research states this is not the most effective approach. The goal is to roll within the same expiration cycle, if possible. I hope this helps.

      Reply
  4. Ahmad Mohammad on

    Thanks Andy for your responses to my questions. I do greatly appreciate your help. By the way, I also made 100% profit on two JPM iron condor trades last week ( $70 profit total) and I am glad you showed me the easy way to safely play earning announcements. Ahmad.

    Reply
    • Andy Crowder on

      Ahmad,

      That is great! I’m glad you found the strategy useful in your trading endeavors around earnings. Just remember, proper position-size is the key to success as we are counting on the law of large numbers to work its magic.

      Reply
  5. Ahmad Mohammad on

    Thanks a lot Andy. I am still looking forward to your article on selling short strangles around earnings announcements. I would like to know how it differs from selling a high probability success Iron Condor?

    Thanks, Ahmad

    Reply

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