Walmart: A Defined-Risk Versus Undefined-Risk Approach Around Upcoming Earnings

walmart-options-strategies-implied-volatility

Next week brings a close to another earnings season. Yes, there will still be some stragglers like Lululemon (LULU), Oracle (ORCL) and several others due to announce in the weeks to come, so expect to see a continuation of the weekly top earnings options plays, but overall we shouldn’t expect to see another full-fledged round of earnings announcements until mid-January.

One thing is certain, earnings season always ends with a bang as some big-box retail stores announce. As you can see in the table below Walmart (WMT), Home Depot (HD) and Target (TGT) are just a few of the big names due to announce.

(click image to enlarge)

earnings-options-trades-november-15-2021

I use this weekly table as a guide to what I want I focus on in the week ahead. It provides me some simple, but important implied volatility readings along with the average move after earnings, which gives me great insight into how I will approach my strategy of choice (which strikes to use, etc.).

As I’ve stated in the past, I hope that by going through a few examples of various options strategies during every earnings season, we can start to build a solid foundation on how to appropriately apply options selling strategies with a focus on high-probability trades.

Today I’m going to focus on Walmart (WMT). The retail behemoth is due to announce before the opening bell on 11/16. I’m going to go through a risk-defined strategy and an undefined risk strategy taking a high-probability approach. I hope this continues to be a helpful exercise for not only trading around earnings, but for also using similar strategies using various timeframes (expiration cycles).

 

Iron Condor Earnings Trade in Walmart (WMT)

Click here for a step-by-step approach to iron condors.

Walmart (WMT) is due to announce before the open next Tuesday. So, let’s take a look at a potential trade using a risk-defined options strategy like an iron condor.

The stock is currently trading for 148.34.

walmart-wmt-earnings-trade

The next item is to look at Walmart’s expected move for the expiration cycle that I’m interested in.

The expected move or expected range over the next seven days can be seen in the pale orange colored bar below. The expected move is from 143 to roughly 153, for a range of $10.

expected-move-walmart-wmt-november-2021-earnings-options-trade

Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 143 to 153.

This is my preference most of the time when using iron condors.

If we look at the call side of WMT for the November 19, 2021 expiration, we can see that the 155 call strike offers an 82.48% probability of success and the 160 strike offers us a 93.03% probability of success. For this example, I’m going to sell the short call at the 155 call strike and define my risk with the 160 call strike. By choosing the 160 call strike to define my risk, I know that there is less than a 7% chance that I will take a max loss on the trade.

expected-move-calls-options-earnings-trade-walmart-wmt

Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 143. The 142 put strike, with an 80.30% probability of success, works as our short put strike. The 142 put strike defines our probability of success on the downside. I’m going to define my risk by choosing the 137 put strike with a 91.74% probability of success.

expected-move-puts-walmart-wmt-options-trade

We can create a trade with a nice probability of success if Walmart stays between our 13-point range, or between the 155 call strike and the 142 put strike. Our probability of success on the trade is 82.48% on the upside and 80.30% on the downside.

I like those odds.

Here is the trade:

Simultaneously:

Sell to open WMT November 19, 2021 155 calls

Buy to open WMT November 19, 2021 160 calls

Sell to open WMT November 19, 2021 142 puts

Buy to open WMT November 19, 2021 137 for roughly $0.90 or $90 per iron condor

Our margin requirement is $410 per iron condor.

Again, the goal of selling the WMT iron condor is to have the underlying stock, in this case WMT, stay below the 155 call strike and above the 142 put strike immediately after WMT earnings are announced.

Here are the parameters for this trade:

  • The Probability of Success – 82.48% (call side) and 80.30% (put side)
  • The maximum return on the trade is the credit of $0.90, or $90 per iron condor
  • Break-even level: 155.90 – 141.10
  • The maximum loss on the trade is 410 per iron condor. Remember, we always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.

A Quick Comparison Between a Walmart Iron Condor Earnings Announcement Trade and a Short Strangle Earnings Announcement Trade

As I have stated over the past few weeks, I would prefer to see a bit higher probability of success on the trade, but that is one of the downsides of iron condors versus, say, a short strangle. When using a risk-defined trade like an iron condor, as we increase our probability of success our potential premium declines.

Click here for a step-by-step approach to short strangles.

For example, if we were using a short strangle, we could sell the 157.5 call strike and the 140 strike and bring in just as much as the iron condor example above.

The difference is an iron condor approach requires less capital and is risk-defined, therefore the percentage return is greater on the iron condor. But, the probabilities are significantly higher when using a short strangle and this is why professionals prefer strangles over iron condors, in most cases.

Again, it must be repeated, a short strangle does not have defined risk but offers a much higher probability of success. In this case, the probability of success if using a short strangle with the 157.5 call and 140 put strikes would be roughly 89.03% on the upside to 86.35% on the downside.

Out total premium would be $90, the same as the iron condor trade. And again, the probability on the short strangle is significantly higher.

That’s a big difference, and again, one of the reasons professionals tend to side with short strangles over iron condors. But remember, there is a time and place for iron condors. And if you want to define your risk, there really isn’t a better strategy to use around earnings.

Remember, I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So, premium could be an issue at the time of the trade. But I like to see where potential trades stand the week prior, so I have a good understanding of what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.

Again, if you have any questions, please feel free to email me or post your question in the comments section below. And don’t forget to sign up for my Free Weekly Newsletter for weekly education, research and trade ideas.

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