GRPN Earnings Trade

Earnings announcements are made by publicly traded companies on a quarterly basis. The earnings announcement will be made after the close of the market or before the opening bell. Because of the uncertainty that surrounds these announcements (stocks can increase or decline significantly after an earnings announcement), the nearest term option prices will be highly inflated due to the high implied volatility (IV). As soon as the earnings are announced, the uncertainty no longer exists and the volatility contracts significantly. The volatility crush that accompanies this type of binary event offers an opportunity to profit by selling premium when the IV is high and buy back (close) the position when IV is low. As long as the stock doesn’t move too far after the announcement, you can do very well with these trades. However, if the price moves farther than expected, it could be a losing trade. For this reason, it is very important that you trade very small with these binary events. Let’s take a look at an earnings trade that I placed this week in Groupon (GRPN).

Groupon was scheduled to announce earnings on Thursday, February 12, 2015 after the closing bell. Looking at the Trade Page on the ThinkOrSwim (TOS) platform we see that the Feb2 15 weekly options which expire the day after the earnings announcement have an extremely high implied volatility of 295.99% (as compared to 135.09% for the Feb 15 options). We also see that the expected move (or Market Maker Move) shown by TOS is +/- $1.054.

GRPN_021215

This expected move is what I typically use to determine where to place my short strikes. In the case of GRPN, the stock is a very low-priced underlying. Had I set my short strikes for an Iron Condor $1.00 on either side of the current price, the premium received would not have been worth the risk. In this particular case, both the short put and call were placed at the $7.50 strike. The $6 put and $9 call were purchased to define the risk.

On Thursday afternoon about 15 minutes before the closing bell, I sold a GRPN Feb2 15 7.5/9/7.5/6 Iron Condor for $0.91 ($91 credit). The width of the strikes is $1.50 which caps the maximum risk for the trade at $150 less the $91 received, or $59.00.

When GRPN opened on Friday morning, the volatility rapidly contracted to 29.78% as seen below.

GRPN_021315

I placed an order to buy back the iron condor for $0.34 ($34 debit) resulting in a profit of $45 after commissions. This is a 76.27% Return on Capital for an overnight trade risking only $59.00.

Seeing these kinds of results might tempt you to want to trade these earnings announcements in a big way. However, I would highly discourage this practice. In this particular case, the stock closed at $7.46 before the announcement and opened the next day at $7.55 which permitted a quick, clean exit out of the trade. Occasionally the stock may move significantly up or down in after-hours trading which can result in the trade being a full loser. I like to think of earnings trades as a lottery ticket with a slightly better than 50% chance of being a winner. I don’t mind risking $59 on a trade like this, but I am not going to risk hundreds of dollars on a binary event. If it ends up being a big loser, it can take a long time to recover the loss.