To The Moon

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Welcome to Tiger Academy - 「Options Academy Column」 Issue 7.

We know that using options to speculate on financial reports is one of the most common ways to make money with options.

However, many people don't quite understand how options can make money and what the relationship is with financial reports. How should we speculate on financial reports using options? Today, we will address this question.

We know that after a company releases its financial report, the stock price tends to fluctuate based on the performance data. In previous articles, we mentioned that if the financial report exceeds expectations, the stock price will rise; if it falls short of expectations, the stock price will decline; and if it meets expectations, the stock price will experience minor fluctuations.

Therefore, when you want to make money by speculating on financial reports using options, the underlying logic is essentially to bet on changes in the stock price and use options to profit. So, how exactly can you do this?

1. How to use options betting on earnings reports?

First of all, let's briefly summarize the basic strategies we have discussed in previous articles:

If the financial report exceeds expectations and you anticipate the stock price to rise, buy call options.

If the financial report falls below expectations and you anticipate the stock price to decline, buy put options.

If the financial report meets expectations and you anticipate minor fluctuations in the stock price, sell call/put options.

Although the strategies are simple, choosing the direction of long or short positions is something that everyone can do. However, it becomes much more difficult to actually make money through implementation. To illustrate this, let me show you a counter-example:

As we can see, Tesla's stock price rose by approximately 6% on that day, but the call option with a strike price of $325 experienced a decline of 21.43%. Why did this happen? There are two reasons:

1.Deep out-of-the-money options with a significant deviation from the current price

When you purchase deep out-of-the-money options, there is no intrinsic value, only time value. Although the stock price increased, the magnitude of the increase was not significant enough to turn the option from out-of-the-money to in-the-money. Therefore, the intrinsic value remained at zero, but a significant amount of time value decayed during the day, resulting in a decline in the option price.

2.High implied volatility when buying options

As we discussed in previous articles, the key to trading options is trading implied volatility. Higher option prices correspond to higher implied volatility. When there is a general market expectation of significant stock price volatility on the day of financial report disclosure, both call and put options from the previous day will increase in price due to this expectation. This leads to an increase in implied volatility, commonly known as an "IV spike."

For example, if the current stock price is $100 and you anticipate a 10% increase in stock price the next day, assuming the implied volatility of the call option is 20%, it means that 20% of the expected stock price increase is already reflected in the option price. Therefore, even if the stock price rises by 10% the next day, the option price may still decrease because it did not reach the expected level of volatility. This is known as "IV crush."

Therefore, if we cannot avoid these issues, even if we correctly guess the direction, there is still a possibility of losing money. So, how can we address these challenges?

2. How to avoid losing money even when you guess the direction correctly?

1.Choose appropriate strike prices and implied volatility

As an option buyer, the greatest risks are unfavorable price movements and time value decay. Therefore, whether you are buying call or put options, it is generally better to choose at-the-money or slightly out-of-the-money options. This allows you to capture the increase in intrinsic value resulting from favorable stock price movements. Additionally, these types of contracts offer higher leverage and maximize profit potential when the direction is correct.

Furthermore, when purchasing options, if the implied volatility is excessively high and exceeds your expected stock price movement, it indicates that the option price is too high. In such cases, it is advisable to avoid being a buyer of options.

However, it's important to note that the implied volatility displayed in the app is an annualized concept and cannot be directly compared with the expected stock price movement. Instead, it should be converted into implied volatility for the holding period. Calculating this conversion can be complicated, so an alternative method to judge whether implied volatility is high is by comparing it with historical volatility. For detailed instructions, please refer to the previous article "Day3.Why do higher stock volatility lead to more expensive options?"

By following these strategies, you can reduce the risk of losing money even when you correctly guess the direction.

2.Be a seller instead of a buyer

Based on the previous examples, we know that when speculating on financial reports using options, buyers not only need to guess the correct direction and choose appropriate strike prices but also rely on significant stock price movements and reasonable implied volatility to offset all these unfavorable factors.

On the other hand, sellers have the advantage in this process. Whether there are minor fluctuations or favorable movements in the stock price, sellers make money. Therefore, if we don't consider the profit amount, sellers inherently have a much higher probability of success than buyers. Additionally, sellers have an advantage in that if they make a wrong judgment and start losing money, there are many remedial measures available. However, once buyers make a wrong decision, the options become worthless, leaving little room for recovery.

Of course, being a seller, although it has a higher probability of success and lower risk, also comes with smaller returns compared to being a buyer. However, this more certain approach is suitable for most investors who are not yet familiar with options trading.

Alright, that concludes today's content. For Tiger Cheese fans who are interested in options trading, we have a free introductory course on options available for you to study.

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See you in the next episode!~