To The Moon

Trading earnings using the implied move and option valuation involves analyzing the market's expectation of a stock's price movement post-earnings release and then strategizing options trades based on this expectation.

In this article, I would like to share on how I have approach this strategy. Here are the implied and option valuation of the stocks which will be reporting their earnings this week.

Abs. Avg Actual Move shows the absolute average stock price percent move for the prior four and twelve quarters of earnings releases. Implied moves and historical absolute moves represent the magnitude of the stock change in either direction. So when implied move is higher than absolute average actual moves, it may be considered overvalued, while implied move lower maybe considered as undervalued.

Under the next few sections, I would be sharing on how implied move is calculated and how we can use it to help us to trade stock which will be reporting earnings.

Step 1: Understand Implied Move

It is important for us to understand what is implied move and how it is calculated and interpret. This could help us to manage the volatility and hence, allow us to adjust our strategy to manage any potential risks.

Implied Move

Implied move refers to the expected magnitude of the stock price movement following an earnings announcement. It is derived from the pricing of options contracts, particularly straddles or strangles.

Calculate Implied Move

To calculate the implied move, add the prices of the at-the-money call and put options expiring soon after the earnings announcement. This gives an indication of the expected magnitude of the stock's movement.

Interpreting Implied Move

Magnitude of Expected Move: The implied move gives traders an idea of how much the market expects the stock price to move in either direction following the earnings report. A larger implied move indicates higher anticipated volatility. (as shown in the above chart, it can be considered overvalued)

Here is an example of how we can use implied move, let me use $SoFi Technologies Inc.(SOFI)$ as an example,

SOFI has an implied move of ±18% ahead of its earnings announcement. This means the market expects the stock price to move up to 18% higher or lower following the earnings report. Since SOFI has a history of moving ±11.40% after earnings, the implied move suggests higher volatility this time.

We could interpret this as increased uncertainty and adjust our strategy accordingly, perhaps by using options to hedge our position or by reducing our position size to account for the higher potential risk.

SOFI close with more than 20% following the earnings report, so it is within the range on the higher band.

Step 2: Analyze Historical Moves

It is important to understand what the past data of earnings is telling us, and there are a lot of tools and websites where we can find these information.

Study Past Earnings Moves

Analyze the stock's historical price movements following earnings announcements. Look for patterns in how the stock has reacted in the past to earnings surprises.

Consider Volatility

Pay attention to implied volatility levels leading up to earnings. High implied volatility suggests higher expected price movements.

With the information of implied moves, we can also looked at how a stock have reacted to past earnings surprises. Another important part would be to look at how the implied volatility levels have changed when leading up to earnings.

Let me show you another example of an upcoming earnings. $Advanced Micro Devices(AMD)$ has an implied move of ±9.50% ahead of its earnings announcement. This means the market expects the stock price to move up to 9.50% higher or lower following the earnings report. Since AMD has a history of moving ±9.60% after earnings, the implied move suggests lower volatility this time.

Lower implied volatility could imply that investors are relatively confident about AMD earnings outcome or that there is less uncertainty surrounding the event.

AMD implied volatility (IV) is 57.7, which is in the 100% percentile rank. This means that 100% of the time the IV was lower in the last year than the current level. The current IV (57.7) is 19.5% above its 20 day moving average (48.3) indicating implied volatility is trending higher.

With the IV trending higher, we might expect a higher price move as investors are pretty confident about AMD earnings.

Step 3: Evaluate Option Strategies

Straddle/Strangle Strategy

Consider using a long straddle or strangle strategy. Long Straddle: Buy a call and a put option with the same strike price and expiration. This benefits from a significant move in either direction. Long Strangle: Buy a call and a put option with different strike prices, typically out of the money. This is cheaper than a straddle but requires a larger price move to be profitable.

Directional Strategies

Based on our analysis of the implied move and historical moves, we may also consider directional strategies like buying calls if we expect a bullish move or buying puts if we anticipate a bearish move.

Step 4: Risk Management

Position Sizing: Determine the appropriate position size based on our risk tolerance and the potential impact of the implied move on our options positions.

Stop Losses: Consider implementing stop-loss orders to limit losses in case the trade moves against us unexpectedly.

Hedging: Depending on our risk appetite, we might choose to hedge ouroptions positions with other strategies or assets.

Step 5: Execution and Monitoring

Execute the Trade

Place the options trades before the earnings announcement, ideally when implied volatility is relatively low compared to historical levels.

Monitor Closely

Keep a close eye on the stock's price movement post-earnings. Be prepared to adjust or exit our positions if the market reaction differs from our expectations.

Take Profits or Cut Losses

If the stock moves in our favor, consider taking profits. Conversely, if the trade goes against us, be disciplined about cutting losses to preserve capital.

Summary

There are some additional considerations that we might want to take note:

Time Decay: Options lose value over time, so we need to be mindful of the impact of time decay on our positions.

Market Sentiment: Consider broader market sentiment and macroeconomic factors that could influence the stock's movement in addition to earnings.

Risk vs. Reward: Assess the potential risk and reward of each trade and ensure it aligns with our overall trading strategy and goals.

Trading earnings using implied moves and option valuation requires careful analysis and risk management. It is essential to have a solid understanding of options trading and market dynamics before engaging in such strategies.

Appreciate if you could share your thoughts in the comment section whether you think implied move and option valuation would be useful to help us in trading earnings?

@TigerStars @Daily_Discussion @Tiger_Earnings @TigerWire appreciate if you could feature this article so that fellow tiger would benefit from my investing and trading thoughts.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.