What are the characteristics of this option strategy?
Earnings option strategies are advanced trades built around a single scheduled event, with a high potential for reward and a higher potential for risk. They assign a high degree of importance to being able to accurately predict the short-term direction of an underlying stock in response to an upcoming earnings announcement. They use the premiums of options contracts, combined with a studious understanding of the underlying company’s business, to trade the volatility created in the market prior to, and following, an earnings announcement.
Is this a bullish, bearish or neutral strategy?
This strategy can be bullish, bearish, or neutral depending on the direction of the market when earnings announcements are made. Long premium earnings trades are exposed to the implied volatility crush that follows the announcement. Implied volatility is bid up before earnings and collapses as soon as the result is known, so a bought straddle or strangle can lose money even when the stock moves in the trader's favour, unless the move is larger than the one the options were already pricing in.
Is this a beginner or an advanced option strategy?
This is an advanced option strategy and requires significant understanding of the underlying asset, its trading history around earnings announcements and the risks associated with trading in volatile markets.
In what situation will I use this strategy?
This strategy is typically used when markets are extremely volatile, such as with short-term, high-impact events such as a major earnings announcements or pricing of a new product.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
There is no single risk-reward number for an earnings trade, because the risk depends entirely on how the view is expressed.
If you buy premium, meaning a long call, a long put, a long straddle or a long strangle, the most you can lose is the debit you paid, and you lose it whenever the realized move is smaller than the move the options were already pricing in. That is the common outcome, because implied volatility is bid up ahead of the report and collapses the moment the numbers are out.
If you sell premium into earnings, the arithmetic reverses and gets much worse. A short straddle or short strangle collects a small credit and carries an uncapped loss, since there is no limit to how far a stock can gap after a bad print. An earnings gap is precisely the event that makes naked short options dangerous, and the credit collected is no cushion against it. If you want to be short premium through a report, a defined-risk structure such as an iron condor or a butterfly, where every short option is covered by a long one, is the only sensible way to do it.
The direction of a post-earnings move is close to a coin flip even for traders who know the company well, so treat any claim of a dependable edge here with suspicion.
What is an example (with calculations) of this strategy?
Take a stock trading at $200 the day before it reports. The trader has no strong directional view but expects a big move, so buys the 200-strike call for $7.00 and the 200-strike put for $6.50 in the weekly expiration, a long straddle costing $13.50 per share, or $1,350 for one contract of each.
The maximum loss is that $1,350, and it is realized if the stock is sitting exactly at $200 at expiration. The breakevens are $200 plus $13.50, which is $213.50, and $200 less $13.50, which is $186.50. In other words the stock has to move more than 6.75% in either direction before the trade makes anything at expiration, and that 6.75% is roughly the move the market was already pricing in when the straddle was quoted at $13.50. Above $213.50 the profit grows with every further dollar of upside; below $186.50 it grows down to a floor of $186.50 per share if the stock went to zero.
The day after the report, implied volatility collapses. If the stock opens at $206, a 3% move that would feel like a win for a directional guess, both options are worth far less than they were the night before and the straddle can easily be marked below the $13.50 paid. Being right about direction is not enough; the move has to be bigger than the one already in the price.
Here are some templates that you can use to create your own models
Diagonal Spread with Calls Option Strategy
Covered Call Option Strategy
Covered Put
Covered Put
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Option Trading With Ms Excel-Protective Puts Strategy
Strap Straddle Options Strategy (Using MarketXLS Template)
Strip Straddle Options Strategy (Using MarketXLS Template)
Earnings Announcement- It’S Impact On Implied Volatility
Difference Between Historical And Implied Volatility