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Earnings periods can be highly volatile, and if you get the Options Trading right, it is possible to achieve a very high ROI.

For example, recently, Reddit (RDDT) released its earnings, with both revenue and EPS far exceeding expectations. After the earnings release, the stock price gapped up the next day, rising by more than 22% at one point during the session.

On the day before the earnings (July 30th), the closing price of a call option with an August 8th expiration and a strike price of $175 was $3.42. By the next trading day after the earnings release (August 1st), this option reached an intraday high of $22.7, a five- to six-fold increase. If it were an even more short-dated option expiring on August 2nd, the price increase would have been even more dramatic!

This example highlights that by using options to position for earnings opportunities in advance, the potential profit can be substantial. Therefore, we will specifically discuss a high-probability options strategy for positioning in high-performing stocks ahead of earnings.

What is the strategy? What is the logic behind it?

The following is not about the lottery-style strategy of buying at-the-money options, nor is it about the volatility-betting strategy of buying straddles or strangles (simultaneously buying calls and puts). Although these strategies have the potential for significant gains, they also carry the risk of total loss. Both are buyer strategies with potentially low win rates.

So, what strategy has a relatively higher win rate? Let's discuss the "Long Call Calendar Spread". This strategy consists of "selling a call with a closer expiration date" + "buying a call with a further expiration date", with both options having the same underlying asset, strike price, and quantity.

Using this strategy before earnings announcements relies on the logic of "time decay benefit (Theta)" + "volatility premium (Vega)" + "long-term value appreciation", effectively a three-pronged approach.

On one hand, the option with the closer expiration date has a higher absolute Theta value (Theta represents the rate at which the option's price decreases over time), meaning its time value diminishes more quickly, leading to gains as the time value accelerates to zero.

On the other hand, the option with the further expiration date has a larger Vega value, indicating that its option price is more sensitive to changes in implied volatility (IV). Before an earnings announcement (e.g., a month prior), the IV of the stock's options often increases, so the value of the further-dated option rises more quickly with the increase in IV, creating a Vega premium by selling the near-term and buying the longer-term option.

*IV is the market's expectation of the range of stock price fluctuations over a future period. If IV is 30%, it means the market expects the stock price to fluctuate within a 30% range over the given period.

Furthermore, since we are trading calls and initially require a net outlay (as the further-dated option is more expensive than the nearer-dated one), this strategy leans towards being bullish. After the nearer-dated option expires, if the stock price continues to rise, the purchased option may continue to appreciate, further enhancing the long-term value.

The risk of this strategy lies in the initial net outlay, which could be entirely lost, representing the maximum potential loss. While the sold option might be exercised, the bought option can also be exercised, offsetting each other. The worst-case scenario is that both options expire worthless.

However, if this strategy is to be used, it is best to enter the market 2-4 weeks in advance and exit when IV peaks (1-3 days before earnings are released). This way, you can fully benefit from the time decay, while avoiding becoming a holder of overpriced IV. It is also advisable to target stocks with relatively stable fundamentals that have just experienced a technical breakthrough and have the potential to become high-performing stocks.

If you are to use this strategy, it is essential to carefully select the symbols!

Based on the above logic, we have a certain range for stock selection (for ease of understanding, specific parameters are assumed below, but in actual operation, these standards and parameters are not unique, and you can set them according to your own judgment):

1. Good Earnings Timing: The earnings release date should be between August 21 and September 4, but avoid the monthly options expiration date of August 15 to prevent being affected by uncontrollable market factors.

2. Good Earnings Track Record: The company has exceeded market expectations in multiple quarters over the past eight quarters, and at least three institutions have raised their full-year earnings forecasts for the company in the last 60 days.

3. Good Technical Indicators: The stock price is above the 50-day moving average, and the 20-day moving average has an upward slope.

4. Good Liquidity: The average daily trading volume over the past 20 days exceeds 50 million.

5. Not Too High IV: The current IV percentile is not higher than 60%.

With these standards, how do you screen individual stocks? Futubull AI can now achieve this with a single click:

If you set more relaxed criteria, you may screen out more individual stocks.

*The content of this article is primarily for presenting a thought process, functional instruction, and practical operation, and does not represent any investment advice.

Using NVIDIA as an example, we will guide you step by step through the process.

Below, we will use NVIDIA as an example to show you how to specifically implement this strategy (for ease of understanding, we will assume specific parameters, but in actual operations, these parameters are not unique, and you can set them based on your own judgment).

1. How to choose the expiration date?

For example, if you choose a closer expiration date, such as August 22 or August 29, this avoids August 15 and is also relatively close to the expiration date, leading to a faster decline in time value; for a further expiration date, choose September 12 or September 19, which provides a certain time window while avoiding paying too much for time value.

2. How to choose the strike price?

If based on a bullish expectation, one can choose at-the-money or slightly out-of-the-money strike prices; if based on a bearish expectation, then at-the-money or slightly in-the-money strike prices should be chosen. This is because the profit range for out-of-the-money options is primarily above the current stock price, while the profit range for in-the-money options is mainly below the current stock price.

For example, with a bullish expectation. As of the close on August 6th, NVIDIA's closing price was $179.42. The corresponding at-the-money option would be a strike price of $180, and a slightly out-of-the-money option would have a strike price of $185.

What are the differences between different strike prices? Choosing a strike price of $185 results in a relatively lower premium, but it requires a more significant price movement to generate a profit. For instance, in the figure below, the stock price needs to be within the range of $178.349 to $192.798 at expiration to make a profit. In contrast, choosing a strike price of $180 results in a profit range of $173.997 to $187.029.

From the figure above, it can be seen that the current strategy's payout ratio is not very favorable, meaning the maximum profit/maximum loss ratio is relatively low.

This situation may arise because the IV of options with a closer expiration date is lower than those with a further expiration date (mainly due to lower short-term event risk and narrower stock price fluctuations), leading to lower selling prices and higher buying prices.

In such a case, one can wait for the IV of the options with a closer expiration date to rebound after a new catalyst (such as an earnings release) before executing the strategy.

4. How to specifically execute the strategy?

① Open the NVIDIA Options Chain, select the "Calendar Spread" and "+3 Exp", and choose the corresponding expiration date and strike price options.

② Scroll down to view the breakeven chart for the expiration date.

③ Click the 'Trade' button, enter the price and quantity, and then click the 'Buy' button.

④ Before trading, it is advisable to observe the Volume and bid-ask spread of these options. In cases of low Volume and high bid-ask spread, potential profits may be adversely affected.

5. How will the prices of these two options change subsequently?

Let's simulate a scenario for August 20th. Assume the net expenditure at the time of establishing the position is $487, and the price of the call option below is calculated using the assumed parameters through the Futubull Option Price Calculator, which may differ from actual results.

6. How can we implement effective risk control?

Firstly, this trade should ideally only represent a small portion of your total capital. Additionally, you can set profit-taking and stop-loss levels. For example, take profit when the ROI reaches ≥ 50%, and cut losses if the loss reaches ≥ 30%. Alternatively, close the position if the expected performance is not met two days before the earnings release.

That's all for today's content. If you have any thoughts or suggestions regarding this strategy and NVIDIA's options layout, feel free to leave a comment and let us know!

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