Today after the close all eyes will be on Netflix, which will report second quarter earnings. The stock is up over 5% today ahead of the announcement, and option traders are betting that the stock trades higher after the release. The biggest trade of the day has been the purchase of 422 180 calls expiring this Friday for an average price of $9.08. This is a bullish bet that has a breakeven of 189.08 at the close this Friday.
The key to trading earnings announcements with options is to understand the implied volatility you are buying or selling. A quick way is to look at the nearest expiring at the money straddle. A straddle is an option spread that is long both a call and put at the same strike and same expiration. Right now the 170 straddle expiring on Friday is trading $26, which means traders are expecting that the stock will be within 15% of 170 at expiration. Most of this move is likely to occur tomorrow, so we can look at Netflix’s historical moves after earnings in order to decide if this volatility is cheap or expensive. In this case it looks to be on the cheap side: the historical average earnings move is 20.5% and the median is 18.0%.
From this it appears that buying options, as opposed to selling them, has the higher probability of success. This trader had the same view on the stock’s volatility, and took the trade a step further by taking a view on the stock’s direction. Instead of buying the straddle, which is a direction neutral strategy, they bought only the calls, suggesting they believe that the stock is likely to gap up more than the market is expecting. In the past Netflix has reported upside surprises 73% of the time, so this has also been the winning trade, historically.
The key to trading earnings announcements with options is to understand the implied volatility you are buying or selling. A quick way is to look at the nearest expiring at the money straddle. A straddle is an option spread that is long both a call and put at the same strike and same expiration. Right now the 170 straddle expiring on Friday is trading $26, which means traders are expecting that the stock will be within 15% of 170 at expiration. Most of this move is likely to occur tomorrow, so we can look at Netflix’s historical moves after earnings in order to decide if this volatility is cheap or expensive. In this case it looks to be on the cheap side: the historical average earnings move is 20.5% and the median is 18.0%.
From this it appears that buying options, as opposed to selling them, has the higher probability of success. This trader had the same view on the stock’s volatility, and took the trade a step further by taking a view on the stock’s direction. Instead of buying the straddle, which is a direction neutral strategy, they bought only the calls, suggesting they believe that the stock is likely to gap up more than the market is expecting. In the past Netflix has reported upside surprises 73% of the time, so this has also been the winning trade, historically.
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