Earnings announcements create some of the biggest moves in the stock market. Options traders can profit from these moves, but earnings trades are tricky because of implied volatility dynamics. Here is how to trade earnings with options.
Understanding IV and Earnings
Before earnings, implied volatility (IV) rises as traders price in the expected move. After earnings, IV drops sharply - this is called IV crush.
Key concept: Even if you correctly predict the direction after earnings, IV crush can still make your trade lose money. The stock can move your way and your options can still lose value.
The Expected Move
The options market prices in an "expected move" for earnings. You can calculate it by:
- Look at the at-the-money straddle price for the earnings week expiration
- That price represents roughly the expected move in either direction
Example
Stock is at $100. The ATM straddle costs $8.
Expected move: approximately $8 in either direction.
Breakeven range: $92 to $108.
For a long straddle to profit, the stock needs to move MORE than $8.
Earnings Strategies
1. Long Straddle or Strangle
Buy both a call and a put to profit from a big move in either direction.
- When to use: You expect a move bigger than the market is pricing in
- Risk: IV crush can hurt you even if the stock moves
- Tip: Compare expected move to historical earnings moves
2. Short Straddle or Strangle
Sell both a call and a put to profit from IV crush and a small move.
- When to use: You expect a smaller move than priced in
- Risk: Unlimited if the stock makes a huge move
- Tip: Use defined-risk versions like iron condors instead
3. Iron Condor
Sell a strangle with protective wings. Profit if stock stays in a range.
- When to use: You expect a muted reaction
- Risk: Defined - you know max loss upfront
- Tip: Set strikes outside the expected move
4. Directional Play with Spreads
If you have a directional bias, use debit spreads instead of single options.
- When to use: You have a bullish or bearish view
- Advantage: Spread reduces the impact of IV crush
- Tip: Buy ITM options to reduce IV exposure
Warning: Earnings are Risky
Earnings are essentially binary events. The stock can gap in either direction, and the move can be irrational. Never risk more than you can afford to lose on an earnings play.
Pre-Earnings vs Post-Earnings
Pre-Earnings Strategies
- Buy options before IV rises, sell before earnings
- Ride the IV expansion without holding through the event
- Lower risk but smaller potential profit
Post-Earnings Strategies
- Wait for the reaction, then trade the follow-through
- Options are cheaper after IV crush
- Trade the trend that develops after the announcement
Tips for Trading Earnings
- Know the expected move before you trade
- Look at historical earnings moves for context
- Use defined-risk strategies when possible
- Size your position smaller - earnings are volatile
- Have an exit plan before the announcement
- Consider the IV crush impact on your strategy
Track Your Earnings Trades
Pro Trader Dashboard helps you analyze your earnings trade performance. See which strategies work best.
Summary
Trading earnings with options requires understanding IV and IV crush. The market prices in an expected move, and you need to decide if you think the actual move will be bigger or smaller. Use defined-risk strategies, size positions appropriately, and always have a plan. Remember that even correct directional calls can lose money due to IV crush.
Learn more: implied volatility and straddles.