Earnings season gets into full swing next week with an array of companies due to report, including Tesla (TSLA), Netflix (NLFX) and a host of other, high-beta stocks. However, while most traders will be looking to trade the higher-beta stocks due to the heightened premium, my intent, as always, is to focus on the boring, lower-beta stocks, like Verizon (VZ).
So, let’s take a quick look at a potential trade in Verizon (VZ) using a short strangle to see if Verizon is indeed in play for this earnings cycle.
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The stock is currently trading for 54.14 and is due to announce earnings next Friday, April 22, before the open.
The next item is to look at VZ’s expected move for the expiration cycle that I’m interested in.
The expected move or expected range over the next 16 days can be seen in the pale orange colored bar below. The expected move is from 52.5 to roughly 55.5, for a range of $3.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my short strangle outside of the expected range, in this case outside of 52.5 to 55.5.
This is my preference most of the time when using strangles. I want my short strangle to have a high probability of success while simultaneously bringing in an appropriate amount of premium. It’s the reason I go through this exercise with the stocks I’m targeting for the following week.
Since Verizon is due to announce towards the latter part of the week I want to look at the expiration for the following week, just in case things go awry. If we look at the call side of VZ for April 29, 2022, expiration, we can see that the 56 call strike offers an 82.29% probability of success and the 56.5 call strike offers us an 86.81% probability of success. Both strikes are above the edge of VZ’s expected move, or 55.5.
Now it’s just a matter of what kind of return we are looking for on the trade. In this example, I’m going with the 56 call strike with an 82.29% probability of success as the 56.5 call strike just isn’t paying enough premium. I should be able to sell the call strike for $0.21.
Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 52.5. The 52, with an 81.32% probability of success, works.
We can create a trade with a nice probability of success if VZ stays between our 4-point range, or the 56 call strike and the 52 put strike. Basically, VZ can move 3.7% to the upside or downside after earnings and the trade would be in good shape. The 3.7% might not seem like a lot of room, but if you look at the historical earnings reactions below, you will see that going back to 10/29/2006, it has been rare to see a move that exceeds 3.7%. The question is whether or not a 4.79% return is worth the risk.
Historic Earnings Reactions
Our probability of success on the trade is 82.29% on the upside and 81.32% on the downside.
I like those odds. But I’m not quite sure I like the premium, especially because I expect it to go lower as we get closer to VZ’s earnings announcement.
Here is the trade:
Simultaneously:
Sell to open VZ April 29, 2022, 56 calls
Sell to open VZ April 29, 2022, 52 puts for roughly $0.43 per short strangle
Our margin requirement is $898.60 per short strangle. Our potential return on the trade is 4.79%.
Again, the goal of selling the VZ short strangle is to have the underlying stock stay below the 56 call strike and above the 52 put strike through expiration in 16 days.
Here are the parameters for this trade:
- The Probability of Success – 82.29% (call side) and 81.32% (put side)
- The max return on the trade is the credit of $0.43, or 4.79%
- Break-even level: 56.43 – 51.57
- The maximum loss on the trade is in theory unlimited. Remember, we will adjust if necessary and always stick to our stop-loss guidelines. Position size, as always, is key.
Short strangles offer options traders one of the highest-probability strategies out there. And that’s why they are one of the strategies of choice amongst professional options traders. Undefined risk strategies can be scary for the uninitiated. But if you understand the risk of the strategy and are diligent with your risk management, a whole new world of trading has just opened up.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.