Options selling, while inherently riskier, presents unique advantages, such as generating income through premium collection and leveraging time decay.
Earnings are known for their unpredictable outcomes, especially if we’re just trying to guess stock directions. But, as we’ll see in this article, strategically navigating volatility with carefully researched positions can actually offer appealing opportunities with reasonable risk for options sellers.
The Impact of Earnings on Options
IV Rush
Earnings periods are notorious for their market volatility. Implied volatility tends to increase in the weeks and days preceding earnings — this is what we call IV rush.
This leads to higher option prices before earnings, resulting in a larger expected move compared to a typical day.
In the example above, we see the rise of IV on the closest expiration straddle in the two days leading to NFLX earnings, and how the straddle (ATM call + ATM put) price rises with it.
IV Crush
However, IV then crashes on the day of the release. This IV crush inflicts a big drop in options prices, adding to the daily theta decay effect.
Below we see the price evolution of the closest expiration straddle for ADBE leading up to earnings, day by day, for a scenario of no stock move at all in order to visualise the effect of theta decay and IV crush — here the release is on the 13th after close, so the first day of trading after earnings is the 14th.
We see the relatively small theta decay effect on the price, decreasing by around ~5% in the days leading to earnings. However, on the 14th, the price drop is more substantial (from about $20.14 to $16.7) because of the IV crush effect.
The stock move on earnings needs to be important enough to counter not only the theta decay but also the IV crush. This is what makes for a higher breakeven than on a random day.
Many traders leverage this implied volatility crush to sell options and capitalise on the elevated premiums.
It’s essential to note that selling options, especially during earnings, carries significant risks. But with thorough research and careful adjustment, earnings seasons can offer lucrative opportunities with favourable risk profiles.
Historical Stock Price Movements During Earnings
Predicting stock movements during earnings is challenging, particularly if the goal is to forecast the direction accurately. Additionally, even when correctly predicting the move’s direction, the crucial factor is the extent of the move required to offset the IV crush as we’ve seen.
At first glance, it may appear to be a straightforward chance to sell options, capitalising on implied volatility crush and closing positions at a much lower cost after the release.
However, the extent of earnings moves differs, and in numerous cases, stock moves can exceed the anticipated move, surpassing the impact of implied volatility crush with the sheer momentum of the stock’s movement.
This shows that the expected earnings move, driven by elevated implied volatility, doesn’t always align with the actual magnitude of the stock’s shift.
As an illustration, here is the distribution of past earnings moves for Adobe for the last 10 years. The x-axis shows the value of the move — this is the highest or lowest recorded move on the day of earnings — and the y-axis shows how many times that move happened.
We see that the range of moves varies from around –20% to +12%, with most moves between the –12% and +12% range, while the –20% move is a clear outlier that happened only once in the last 10 years.
Implied Move vs Past Moves
When discussing the implied move, we typically focus on nondirectional positions. We examine the pricing of the closest expiration straddle, which involves an at-the-money call and put.
Analysing the historical moves provides valuable insights into evaluating the current implied move.
As of the time of writing this, Adobe’s implied move is approximately ±6%, and we observe that it aligns reasonably well with past distributions.
Note that the implied move refers to the breakeven of the classic straddle with the nearest expiration. While it offers a sense of expectations, calibrating positions allows us to achieve lower or higher breakeven points.
Ideally, we aim for a position with a broad enough breakeven range to encompass the expected move, considering outlier scenarios to avoid being caught off guard.
Strategies for Options Sellers During Earnings
Covered Calls & Cash-Secured Puts
Options selling involves two primary positions — covered calls and cash-secured puts.
In a covered call, traders who already own the underlying stock sell call options against it, generating income from the premium while potentially limiting the upside profit.
On the other hand, cash-secured puts involve selling put options with enough cash to cover the potential purchase of the underlying asset if the option is exercised.
When it comes to earnings, one can take the same approach.
We can draw insights from historical move distributions to establish an upper and lower range — selling calls or puts with a sufficiently wide breakeven.
Take the Adobe example above — a short call with a breakeven around +8% and a put around –10% seems relatively secure, given that most past moves fell within these limits.
It’s crucial for any sold position to have its breakeven benchmarked against the distribution of past moves.
The advantage of exclusively employing short calls or puts lies in the fact that for a loss to occur, the stock must not only move in a particular direction but also with a specific magnitude.
This improves the likelihood of success. However, the drawback is that the collected premium is relatively modest while still carrying some exposure.
For instance, selling naked calls could lead to significant losses if the stock surges well above our breakeven — a scenario akin to picking pennies in front of a steamroller.
To mitigate such risks, a good workaround is using spreads, purchasing a further out-of-the-money call or put, even if these extreme situations are infrequent.
Neutral Strategies
Instead of choosing a specific direction for the move, a more effective strategy is to adopt a non-directional approach, commonly known as delta-neutral positions.
This involves selling both calls and puts in combination to achieve a position that remains indifferent to direction. The focus shifts solely to the extent of the move, making the stock direction less important than the size of the move.
Short Straddles
A classic approach for this is the short straddle. To maximise gains from implied volatility crush, we typically opt for the closest expiration since IV crush diminishes with more extended expirations.
Now, our breakeven spans a range of moves in both directions. The strategy is centred on the belief that the actual move will remain within this breakeven range, allowing us to repurchase the straddle at a significantly lower cost due to the impact of IV crush.
In the context of Adobe earnings, let’s look at a simulation of a short straddle with the closest expiration — the 632.5 call and put with an expiration on 12–15, around the close a day before release.
The premium collected is about $37.53. The left panel of the simulator illustrates the anticipated crush in implied volatility, from 69% to 46%. More crucial than the raw IV values is how they translate into breakeven terms on the day of release, accounting for both IV crush and theta decay.
The breakeven for this straddle on 12–14, the first day of trading after the release, is roughly ±5%, signifying safety as long as the stock move stays within that range.
The price chart depicts the straddle’s price evolution throughout the week, showing that on 12–14, its price will drop to about $16.74 if the stock doesn’t move at all — our best-case scenario where we can repurchase it on the release day and pocket the difference.
Based on the prior moves analysis, the ±5% breakeven appears well-priced, closely aligned with the past average move over the last 10 years and situated in the middle of the moves distribution.
Higher Risk / Reward: Short Strangles
A riskier version is a short strangle.
Here we look at the short strangle (e.g. 630 call / 585 put, 12–15 expiration). We observe a breakeven range of roughly –7% to +6%. This provides profit potential — selling the strangle for about $14.07 and buying it back for around $2.62 by Thursday in case of no stock move at all.
However, it also exposes us to significant losses in case of outlier moves. In the simulator we can see the whopping ~400% loss at around ±21% move, where we would have to buy back the position for more than $100 per contract.
This is what we call pennies in front of a steamroller.
Capping Losses: Using Butterflies & Condors
To address potential losses, we transition to a condor-type strategy by buying out-of-the-money calls and puts.
This caps our losses in case of a big move as the sold leg will be compensated by the further bought leg, but it also reduces our potential profit — for example, selling for around $9.40 on Monday and buying back for about $2.42 in a no-move scenario.
Most importantly, we see how at the extreme scenario of a ±21% move, the loss is reduced by nearly 4× compared to the pure short strangle.
Avoiding IV Crush: Next Expiration & Calendars
To minimise potential losses, it’s often helpful to decrease vulnerability to implied volatility crush.
The dynamics of IV rush and crush during earnings are particularly impactful on the option with the closest expiration and gradually diminish with subsequent expirations.
Opting for the next expirations helps streamline your risk and reward profile, offering a more conservative approach to navigating earnings.
Other possible strategies are calendars, also known as horizontal spreads or time spreads. A calendar spread involves simultaneously buying and selling options of the same type (either calls or puts) but with different expiration dates.
These can be a strategic tool to mitigate exposure to IV crush, especially during earnings periods: the short-term option, being more susceptible to IV crush, experiences a decrease in value, but the longer-term option retains some of its premium.
Putting It All Together
In summary, earnings — often viewed as mere speculative trades — can serve as a structured strategy for income generation through options selling.
It is crucial to emphasise that this is not an effortless opportunity for free money. Instead, as demonstrated, success relies on:
- Meticulously calibrating positions against historical move distributions
- Benchmarking breakevens against realistic outlier scenarios
- Choosing a risk profile (straddle, strangle, condor, calendar) you’re genuinely comfortable with
- Using defined-risk structures wherever large gaps are possible
Make sure to explore the capabilities of the EarningsWatcher platform — from Moves Analyser to the Simulator — to further enrich your earnings trading and stress-test your short-volatility ideas before you commit real capital.
- Review the basics of IV rush, IV crush and implied moves in the EarningsWatcher wiki.
- Use the Moves Analyser to compare implied moves to historical distributions for your favourite tickers.
- Model short straddles, strangles and condors in the Simulator and practice in paper trading before scaling up.