After a massive bull run, the broader markets are under pressure, and S & P 500 is already testing its long term support near the 200-day moving average. This week is littered with tech earnings and if something can save the markets from sliding into bear market territory, it is the mega cap stocks like Microsoft, Alphabet, Amazon and Meta, which are all reporting earnings this week. Microsoft, which reports earnings after market close on Tuesday, is the second biggest component of S & P 500 by weight. If we look at the last four quarters of MSFT earnings, you can see that MSFT has been the star of the show, beating analyst estimates every single time. In terms of volatility, MSFT is mostly a stable stock and doesn’t move around too much. April brought an outlier move as the AI hype wave was just beginning to unravel. Irrespective of the outlier move, MSFT’s price movement is well contained within the 10% range. For highly liquid stocks, most options trading platforms (ThinkorSwim shown here) can use the IV (implied volatility) to calculate how much the options market is pricing the stock to move after earnings are announced. In the example below, the option chain for MSFT is showing an expected move of plus or minus $15 (in either direction). Once earnings are announced, options experience a phenomenon called “IV implosion” which causes the option premium to deflate almost instantaneously like a leaky air balloon. By selling this Iron Condor on the day before earnings, one can take advantage of selling IV when it is at its highest and buying it back the next day when the IV deflates. You are in essence shorting IV instead of a stock. From the above options chain, we can glean two 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 Wednesday morning. We also know how much post earnings price movement the options market is pricing in for MSFT ($15 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 is 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? Setting up the Earning Iron Condor Selling an Iron Condor is an options trading strategy where you simultaneously sell out-of-the-money call spreads and put spreads. Since you are selling spreads (instead of selling naked calls and puts, your 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: 1. Which strikes to choose to sell the call spread? 2. Which strikes to choose to sell the put spread? 3. 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 you to sell an Iron Condor with minimal effort. To construct the put spread that I will be selling, here is what I need to do: The option chain above shows that $330 (current price) – $15 (expected move) is $315. The trading platform even shows the probability of the expected move. In this case, there is an 80% chance of MSFT not dropping below 315. I could sell a $315 put option and buy a $310 put option at the same time (thereby constructing our put spread side of the trade) For the call spread side of the equation, I need to do something similar: Again, the option chain above shows that $330 (current price) + $15 (expected move) is $345. This means that MSFT is approx. 80% probability of MSFT to not pop above $345. I could sell a $345 call option and buy a 350 call option simultaneously. This wraps up the call side of the equation. Most trading platforms will allow traders to put this trade as one unit by selecting “Sell Iron Condor” as the trade structure. Trade Structure and Analysis: SELL -1 MSFT $345-$350 CALL/$315-$310 PUT Iron Condor CREDIT (also max profit): $167 MAX LOSS: $333 Trade Execution: These post earnings trades are quick. Traders put them on one to two hours before the market close on the day earnings are about to be announced. This maximizes the premium you will capture on the trade. One may notice that the premium you are receiving goes up the longer one waits 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 I can make 50% on capital risked in a single day which is very lucrative, I would want to place a closing order for 50% of that profit target. i.e $83. This is still a substantial 25% return in less than 24 hours. I can always tweak this profit target by watching MSFT’s earnings reaction on Tuesday after market close. Eg. If MSFT shows hardly any price movement, then I can shoot for the full profit target of $167 too. Since these trades are high probability trades, one could 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), I will usually see the stock in question give up some of its post earnings gap in the first hour of market open. This would be time I would 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 I take enough trades for the probabilities to work out in your favor. Want to play safer? (Try an unbalanced Iron Condor) This trade has 80% chance of success based on options probabilities. Want to widen your safety net? If you scan the option chain and look at the “Probability OTM” column on the put side, you will see that the $305 strike has an almost 90% probability of expiring OTM (out of the money). Depending on your directional bias, you can always increase your protection on the call or put side. Let us say, for example, I feel that the AI hype is behind us and if MSFT does not deliver on their AI promise with some concrete revenue numbers, the real risk is to the downside. So to increase my protection on the downside, I can simply change the put spread from the original $315-$310 put spread to a $305-$300 put spread. By doing this, I will now be creating an unbalanced Iron Condor. The put spread has a 90% probability of success and the call spread has the original 80% probability of success. By making these small tweaks, I can adjust your risk/reward easily to match your directional bias. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
