Should You Sell Options During Earnings?
A question I get asked A LOT is, “Should you sell options during earnings?”
Earnings season happens four times every year so it’s something we always have to deal with as traders.
On one hand, volatility is much higher during earnings season so there is an opportunity for earning more premium. But on the other hand, we often see wild swings that could easily go against you. So how do we trade this volatility?
In this article, I’m going to provide you with a very specific trading strategy for selling options during earnings season. This is actually a real-life trade I made earlier this week.
Let’s get started!
A Review of Selling Options
First, let’s do a quick review of selling options. Many of you are probably familiar with buying options. Selling options is an excellent way of earning a premium as income.
There are a number of different trading strategies you can use, but personally, I like to use the Wheel Strategy and the PowerX Strategy. I’ve gone into great detail about these strategies in the past so I won’t take up too much time doing that in this article!
When it comes to selling options during earnings, let’s look at it from a high level. As I mentioned, there are two main things to consider: higher volatility and potential large moves against you.
I’m going to start with number two: potential large moves against you.
Since there is so much potential for wild swings in prices, I don’t like to sell put options going into earnings.
I do, however, like to sell call options, and here’s why. When you sell puts, you have to buy the stock at the strike price you sold the option at, if you get assigned. Let’s take a look at a very specific example right now.
Novavax Earnings Example
Let’s use Novavax (NVAX) as an example. Now, I didn’t take this trade. I’m just using it as an example here. I’ll get to my trade in just a moment.
So as you can see, Novavax reported earnings last week and the markets did NOT like them. The stock plummeted by more than 30%.
If you had sold the $52.00 put, and Novavax kept falling to let’s say $35.00, you would have to buy NVAX shares at $52.00 at the expiration date. That means you are automatically $17.00 in the hole. With a strike price of $52.00, that would mean you are down by 33%! Not a great start.
So that is why I never sell puts with an expiration date before an earnings report. Our option scanner tool, the PowerX Optimizer, can automatically filter these stocks out so I don’t even see them. It just makes my life easier.
Tapestry Earnings Example
However, I do like to sell call options during earnings. Here is an example of the trade I made last week with the stock Tapestry (TPR).
Let’s jump back a bit because a while ago I sold put options on Tapestry and was assigned at $37.00.
So in my account, I owned 2,700 shares of TPR at a cost basis of $37.00. Since I owned these shares, I could now sell calls against these shares. This strategy, as I’m sure you know, is called selling covered calls.
When I sell calls I want to make sure I receive enough premium to make about 30% annualized.
Tapestry is set to report its earnings on August 19th, which is after the expiration date I had, August 12th.
Let’s look at Tapestry’s options so you can see what is happening when you sell options into earnings.
Okay, so I want to sell calls on TPR at a strike price of $37.00 because that is my cost basis. Looking at next week’s expiration date with 2700 shares, let’s see what kind of premium we can get.
On my trading platform, I can see that the Bid-Ask is $0.45 over $0.55. This means that I think we can get the mid-price of about $0.50. That’s pretty good because it would give me about $1,350 in premium.
Doing some quick math, I would make about $135 per day or 49% annualized.
Should we Trade Tapestry so Close to Earnings?
The question is: does it make sense to make this trade since they report earnings the day before expiration?
I like to look at the earnings analysis to find a better answer. Historically over the last 20 quarters, Tapestry has beat earnings 17 times and missed only twice. The other time it was exactly as expected.
We can also see the price move reaction on the seventh day following earnings. So after seven days, how much did the stock move? Here it’s telling me that Tapestry was up 37% of the time and down 63% of the time. Does that help me?
One more thing I like to look at here: when there was a surprise to the upside it moved higher by 11.8%. When it went lower it was by about 5.8%.
Looking at the past few earnings we see it went up 18%, down 2%, up 8%, down half a percent, then down 2%. So this tells me the surprise is always to the upside.
The last time they had a down move of 18% was April 2020. As you probably remember, this is during the COVID crash at the start of the pandemic. All stocks were going down and it had very little to do with earnings.
So what does this mean for selling my calls on Tapestry? This is where I would consider speculating if I want to take advantage of a possible move higher.
I’ll do the same calculation, but instead of the $37.00 call, I’m going to do the $38.00 call instead. Let’s see how much premium we would make.
On my trading platform, the last traded price was $0.33, so I think I can probably get $0.35. I can see that if we make it 35% we would receive $945 in premium.
Why Would You Do This Trade?
Now you’re probably wondering: why would you do this?
You can make $1,350 in premium so why settle for less? Well, if the stock moves past $38.00 after earnings I am making an additional $2,700 by selling the shares, rather than just the $1,350 in premium at the $37.00 strike price.
So the $1,350 is a bird in the hand, but the $3,645 is the two in the bush if we have a surprise to the upside. Does that make sense?
Summary: Selling Options During Earnings
This is why I believe that looking at the earnings analysis is so important when it comes to trading during earnings. This helps me to make a decision of whether it makes sense to sell at the assigned price or move up in the strike price and capture the potential high upside move.
For my Tapestry trade, this is what I chose to do.
To recap, I am selling 27 calls of Tapestry at $0.35 and collecting $945. If by the expiration date of August 19th, TPR is above $38.00, then I also make an additional $2,700 on the stock.
One more important topic that is related to this is buying back these call options that I am selling to maximize your profits even more!
I made another video on this, you can check it out HERE.
I hope this helped and answered any questions you might have had about selling options during earnings.