Expected Move Butterflies for Earnings
Oct 24, 2023
Earnings are always totally random. You don’t know what the company will report, and you have no clue how the market will respond to whatever the company does report. Regardless of the prognostication coming from your favorite prognosticator, the directional move post earnings is always a crapshoot. Just the same, earnings announcements offer premium sellers plenty of opportunities because of the potential for an explosive move and inflated implied volatility.
So it may be time for a strategy called the “expected move butterfly.”
Given the unpredictability surrounding the stock market reaction to an earnings report, keeping an eye on the risk of these events is a prudent move, and an expected move butterfly gives you a low-risk way to take a directional shot. The most you can lose on a standard expected move butterfly with symmetric wings is the debit you pay. So it’s easy to shrink your size on order entry and significantly reduce your risk.
Yes, no one knows how a stock will react to an earnings call, nor how far it might run in one direction or the other. But the probabilities of the marketplace still produce an expected move heading into the number. By anchoring the sweet spot of your expected move butterfly (the short strikes) right on the edge of the expected move to the side of the market you think the stock might move, you’re able to harness the power of statistics as you build this earnings strategy.
And the best part? Not only are expected move butterflies low-risk strategies, but they’re also high-potential-return strategies, too. So if you totally miss the mark, and the stock immediately runs the other way and never looks back, not much is lost. You forfeit the debit paid and move on to the next trade. But if you nail the directional move, without missing the mark too badly on its magnitude, you could be looking at a really nice payday.
Jim Schultz, a quantitative expert and finance Ph.D., has been trading the markets for nearly two decades. He hosts From Theory to Practice, Monday-Friday on tastylive, where he explains theoretical trading concepts and provides a practical application of those concepts to a trading portfolio. @jschultzf3
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