A high-probability trade on Netflix into earnings used by options traders

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Netflix (NFLX) kicks off tech earnings on Wednesday after the market close. For many, NFLX is the harbinger of how the rest of the sector’s earnings will play out. As the earnings date starts approaching, it brings a lot of uncertainty with it. Everybody knows that earnings announcements can bring a big price move, but it is difficult to predict the direction of the price movement. Let us start by examining the historical price movement in NFLX after the last four earnings events. You will notice that most of the earnings moves are mostly contained within 9%. There can always be outliers like that 13.3% move in Oct. 2022 as NFLX is a volatile stock and any surprise beat (or miss) on subscriber numbers is usually enough to move this stock massively. As traders place their bets on an upcoming event like this, demand for options increases, and the price of options that expire just after earnings is inflated by supply and demand. The “juice” or “premium” on these options is known as implied volatility, or IV. For highly liquid stocks, most options trading platforms (ThinkorSwim shown here) can use this IV to calculate how much the options market is pricing the stock to move after earnings are announced. In the example below, the expected move for NFLX is showing as plus or minus $30 (in either direction). Once earnings are announced, the surprise factor is gone, and the IV (implied volatility) of the options comes out like air from a leaky balloon. This is instantly reflected in options pricing on the following day after earnings, and options lose all this inflated juice thereby dropping drastically in value. (This “IV Implosion” is also the reason why options buyers almost always lose money during earnings even when the stock goes in the direction they were betting in). From the above options chain, we are able to glean a few very important pieces of information: We know that the IV is highly inflated and we also know that all that premium (or juice) will come out of the options on Thursday morning. We also know how much post-earnings price movement the options market is pricing in for NFLX. ($30 up or down) We do have a big unknown – the direction of the move. But for this trade set-up, we don’t really care about that as the above two pieces of information are all we need to put on this trade. Can you think of a way of exploiting the inflated IV and the fact that you are able to see with a decent level of accuracy, how much the stock might move after earnings? Enter the earnings iron condor Selling an Iron Condor is an options trading strategy where a trader simultaneously sells out-of-the-money call spreads and put spreads. Since the trader is selling spreads (instead of selling naked calls and puts, the risk and reward are both defined at the time of entry). To construct this trade, all we need to do is figure out two things: Which strikes to choose to sell the call spread? Which strikes to choose to sell the put spread? Once we figure this out, all we have to do is enter this entire trade as 1 single unit also known as an Iron Condor. Most trading platforms will allow traders to sell an Iron Condor with minimal effort. To construct the put spread that we will be selling, here is what we need to do: The option chain above shows that $355 (current price) – $30 (expected move) is $325. This means that NFLX is not expected to drop below $325. We could sell a $325 put option and buy a $320 put option at the same time (thereby constructing our put spread side of the trade). For the call spread of the equation, we need to do something similar Again, the option chain above shows that $355 (current price) + $30 (expected move) is $385. This means that NFLX is not expected to pop above $385. We could sell a $385 call option and buy a $390 call option simultaneously. This wraps up the call side of the equation. Trade execution: These post earnings trades are quick. Traders put them on 1 to 2 hours before the market close on the day earnings are about to be announced. This maximizes the premium they will capture on the trade. The premium traders receive goes up the longer they wait to put on this trade. Although this trade has approx. 80% probability of success, as is the nature of high probability trading, the risk is higher than the max profit. So, we need to have clearly defined risk/reward targets for this trade. Although a trader can make 57% on capital risked in a single day which is very lucrative, I will want to place a closing order for 50% of that profit target. i.e $91. This is still a substantial 28.67% return in less than 24 hours. Since these trades are high probability trades, I expect 8 out of every 10 trades to become winners and the winners add up quickly. If the post-earnings move is larger than the expected move (and this does happen every now and then), the stock in question will give up some of its post-earnings gap in the first hour of market open. This would be time I will want to get out of the trade instead of letting it go to full loss. Since the losers are only 2 out of 10 (assuming 80% win rate), i could close the losers at 60% – 70% loss and still come out as a winner once you take enough trades for the probabilities to work out in your favor. DISCLOSURES: (none) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . 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