Options and Earnings

by Adam Beaty

Before we start, this play is high probability, high risk, and very short term..

This will be a play with options where we sell premium before earnings are reported to take advantage of the inflated prices.  Lets look at the options on April 25th at the market close, this is an hour or so before earnings are reported but since option prices are not affected in after hours it allows us to view the prices.

Here are the Straddle prices at the close for the weekly expiration at April 29th.  A straddle is a purchase of a put and call with the same strike and maturity with the hopes of capturing a large move in either direction.  Netflix was trading at 251.xx so the ATM straddle is the 250 strike with an implied volatility around 107.44% (huge volatility).  We use the ATM straddle to see what the market has priced for a move.  Here we see a 24.85 move in either an up or down direction, so that puts upper and lower limits at 274.85 to 225.15, respectively.  That is approximately a 10% move in either direction. 

Okay so now we know what the market is expecting, how do we trade it?

Lets look at the single options on April 25th.

Here is a look at the puts from 225 - 200.  The market believes that the move could reach down to 225 so we will ignore those at this point.  We will be looking for a safer route so we can collect easy premiums.  To be safe we would venture down to the 205s which we could sell for .445 (mid-price).  Picking the 205s gives us approximately 45 points of cushion or 18% wiggle room.

But we don't want to be directional biased here - so lets look at the calls too.

Again these are the single options expiring on Friday April 29th.  We will look at the call options between 275 to 295.  Since the market has priced in the move to 275 we will go ahead and ignore those again.  We are going to go ahead and look at the 295s which will give us a 45pt (18%) window from the current stock price.  We could sell those at .58 (mid-point) premium.  I will use this time to go ahead and point out the difference in premiums between the 205s and the 295s - both are 45pts away from the stock price yet the calls are getting a lot higher price, and you can notice this same phenom happening in all the strike prices.  This is actually skewing the prices, normally puts should be higher and that is from people buying protective puts.  Puts being more expensive is a normal occurrence in option trading and not just around earnings, so having the skew shows that the market really believes we will get a break to the upside. (as we see the market is typically wrong)

So lets recap real quick.  Here are our positions:

Short NFLX 205s @ .445

Short NFLX 295s @ .58

Total credits = 1.025 or $102.5

So how did the position turn out?

As we now know NFLX beat expectations but provided a grim outlook for future quarters.  This was enough to drop NFLX quickly in the after hours market which finished down 5-6%.  Today (April 26th) the market opened and NFLX traded up for a little bit and then quickly fell down and closed today down -9.04% at 228.91.  Wow, market priced that move at 225.15 and it came within 3 points, but lets look closer at the options.

Here is the option prices at the close of April 26th.. One thing to point out is that implied volatility is now down to 49.44% (50% loss in volatility).

We will want to focus on the 205s since that was our position.  Even with a 9% drop in price today the option price is now at .18 which is a .265 drop overnight.  Take a look at the 225s yesterday they were 2.69 and today 2.39 or a drop of .3.  This brings up the point of watch implied volatility and how it can effect your option prices.

Here is a look at the calls and again we will focus on the 295s which was our position.  Right now the 295s are trading at .015 which is a .565 drop overnight.  This is the reason we went ahead and looked for a position on both sides (i.e. puts and calls) that way it didn't matter the direction we had a play either way.

Here is our position and profit breakdown

Short NFLX 205s @ (now) .18

Short NFLX 295s @ (now) .015

Debit if we closed = .195 or $19.5

Profits = (credit) 1.025 - (debit) .195 = .83 or $83 or 80.9% of total credit available.

Our recommendation here would have been to close at the end of today collecting a .83 profit for one day of work.  Obviously these figures don't include commissions which vary between brokerages.  However, it is clear to see where profits could be made even if you only sold one call and one put. 

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