Option Strategy During Earnings Season

Option Strategy During Earnings Season

Very often, stock prices can gap up or down on the next opening session, immediately after quarterly earnings are announced. Such directional risk can be largely mitigated by using the underlying Options.

For example, AAPL is announcing its quarterly earnings today after bell. You had earlier Shorted 100 shares of AAPL at $200. Of cos, if you now have an opinion that AAPL may release a set of sterling earnings, you may choose to close off your Short position and that would totally remove all risk. But with no risk, comes no possible rewards.

Since you are already Short 100 shares of AAPL, you want to maximize your potential for profits but remove as much directional risks as possible. Just in case, AAPL gaps up on open the next morning, as a protection, you can establish the following Option position :

200 of Long $200 Call Options

By having Long Calls, any upside gaps next morning will protect your Short stock positions.

Hang on... you only Shorted 100 shares of AAPL, so why buy 200 of AAPL Call Options when 100 seemingly would suffice?

The answer lies in one of the Option Greeks, namely Delta.

At-The-Money options possess 0.5 delta, whereas 1 Short share of AAPL has -1 delta. Therefore, you need 2 ATM options (2 x 0.5) to equal 1 stock share.

Portfolio Recap :

Short 100 shares AAPL @ $200
Long 200 $200 Call Options

GREEKs Profile :

Delta : 0 (Short 100 shares = - 100 deltas, Long 200 Call Options = +100 deltas)
Gamma : +0.06
Theta : - 0.24
Vega : +0.40

Note that Delta is 0, which means you will not gain or lose no matter how AAPL price moves the next morning. You have effectively removed directional risks arising from earnings announcement. At least this is how it will appear.

In reality, Delta of these 200 Call options will change, when AAPL price moves away from $200 mark. The Delta will change because of Gamma. The overall value of the Long Call will also be affected by Theta and Vega, which are also NOT zero.

If you were Long 100 shares of AAPL, then by going Long 200 options of $200 Puts, will achieve the same direction neutrality to your portfolio. The overall Delta will be again 0, and the remaining GREEKS will largely be the same as above.

We can discuss the impact the remaining Greeks have on this portfolio later. Please feel free to chuck in at any time.

But for now, you can appreciate that using Options, you can immediately remove a chunk of directional risks, without having to liquidate the stock position.