Next week offers a few more trading opportunities as we enter into the heart of earnings season. Several large-cap stocks with highly liquid options are due to announce.
So far, due to our patience in the selection process, this earnings season has allowed us to make several nice profits.
Next week we will focus on a few of the bigger, lower-beta names like ExxonMobil (XOM), United Parcel Service (UPS), Merck (MRK) and a few others. Boring, low-beta stocks are always my preference. Remember, this isn’t a strategy that attempts to hit home runs. Singles and doubles are the goal coupled with strict risk-management guidelines, mostly seen through proper position size. As I stated last week, the Netflixes of the world typically don’t make the cut, even though the premium can be appealing. Both Facebook (FB) and Alphabet (GOOG), among other high-flyer stocks, are due to announce next week, but given the post-earnings performance for many of these stocks I almost always stay away. Again, the law of large numbers determines our fate. The key is to stay consistent and allow the statistics to work in your favor.
Here is an early look at a potential earnings trade for next week. Hopefully this helps a few of you with the mechanics of the trade.
Iron Condor Earnings Trade in ExxonMobil (XOM)
ExxonMobil (XOM) is due to announce before the open next Tuesday. So, let’s take a look at a potential trade using a risk-defined options strategy like an iron condor.
The stock is currently trading for 75.12.
The next item is to look at XOM’s expected move for the expiration cycle that I’m interested in.
The expected move, or expected range, over the next seven days can be seen in the pale orange colored bar below. The expected move is currently from 72 to roughly 78, for a range of $6.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of the 72 to 78 range.
This is my preference most of the time when using iron condors.
If we look at the call side of XOM for the February 4, 2022 expiration, we can see that the 80 call strike offers an 87.83% probability of success and the 81 strike offers us a 91.60% probability of success. For this example, I’m going to sell the short call at the 80 call strike and define my risk with the 85 call strike. By choosing the 85 call strike to define my risk, I know that there is less than a 2% chance that I will take a max loss on the upside portion of the iron condor.
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 72. The 70 put strike, with an 87.83% probability of success, works as our short put strike. The 70 put strike defines our probability of success on the downside. So, I’m going to define my risk by choosing the 70 put strike with an 83.54% probability of success.
We can create a trade with a nice probability of success if ExxonMobil stays between our 10-point range, or between the 80 call strike and the 70 put strike. Our probability of success on the trade is 87.83% on the upside and 83.54% on the downside.
I like those odds.
Here is the trade:
Sell to open XOM February 4, 2022 80 calls
Buy to open XOM February 4, 2022 85 calls
Sell to open XOM February 4, 2022 70 puts
Buy to open XOM February 4, 2022 65 for roughly $0.54 or $54 per iron condor
Our potential return on the trade: 12.1%
Our margin requirement is $446 per iron condor.
Again, the goal of selling the XOM iron condor is to have the underlying stock, in this case XOM, stay below the 80 call strike and above the 70 put strike immediately after XOM earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 87.83% (call side) and 83.54% (put side)
- The maximum return on the trade is the credit of $0.54, or $54 per iron condor
- Break-even level: 80.54 – 69.46
- The maximum loss on the trade is $446 per iron condor. Remember, we always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.
Remember, I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So, premium could be an issue at the time of the trade. But I like to see where potential trades stand the week prior, so I have a good understanding of what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.
Again, if you have any questions, please feel free to email me or post your question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.