IBM announces earnings on October 17, less than three weeks from now. I would like to share with you a strategy I used today to take advantage of the extremely high option prices which exist for the option series that expires on October 21, four days after the announcement. I feel fairly confident I will eventually make over 100% on one or both of these trades before the long side expires in six months.
IBM Pre-Announcement Play
One of my favorite option strategies is to buy one or more calendar spreads on a company that will be announcing earnings in a few weeks. The option series which expires directly after the announcement experiences an elevated Implied Volatility (IV) relative to all the other option series. A high IV means that those options are relatively expensive compared to all the other options that are trading on that stock.
IV for the post-announcement series soars because of the well-known tendency for stock prices to fluctuate far more than usual once the announcement is made. It may go up if investors are pleased with the company’s earnings, sales, or outlook, or it may tumble because investors were expecting more. While there is some historical evidence that the stock usually moves in the opposite direction that it did in the week or two leading up to the announcement, it is not compelling enough to always bet that way.
IBM has risen about $5 over the last week, but it is trading about equal to where it was two weeks ago, so there is no indication right now as to what might happen after the announcement.
IBM has fluctuated by just under 4% on average over the last few announcement events. That would make an average of $6 either way. I really have no idea which way it might go after this announcement, but it has been hanging out around it/s current level (just under $160) for a while, so I am planning to place my bet around that number
In the week leading up to the announcement, IV for the post-announcement series almost always soars, and the stock often moves higher as well, pushed higher by investors who are expecting good news to be forthcoming. For that reason, I like to buy calendar spreads at a strike slightly above the current price of the stock in hopes that the stock will move toward that strike as we wait for the announcement day. Remember, calendar spreads make the greatest gain when the stock is exactly at the strike price on the day when the short side of the spread expires.
This is the trade I placed today when IBM was at $159 (of course, you may choose any quantity you are comfortable with, but this is what each spread cost me):
Buy To Open 1 IBM 21Apr17 160 call (IBM170421C160)
Sell To Open 1 IBM 21Oct16 160 call (IBM161021C160) for a debit of $4.71 (buying a calendar)
Each spread cost me $471 plus $2.50 (the commission rate charged to Terry’s Tips subscribers at thinkorswim), for a total of $473.50. I sold the 21Oct16 160 call for $354. In order to get all my $473.50 back once October 21st rolls around, I will have 25 opportunities to sell a one-week call (if I wish). Right now, a 160 call with one week of remaining life could be sold for about $.90. If I were to sell one of these weeklies on 6 occasions, I would get my entire investment back and still have 19 more opportunities to sell a weekly call.
Another way of moving forward would to sell new calls with a month of remaining life when the 21Oct16 calls expire. If IBM is around $160 at that time, a one-month call could be sold for about $2.00. It would take three such sales to get all of my initial investment back, and I would have three more opportunities to sell a one-month call with all the proceeds being pure profit.
Before the 21Apr17 calls expire, another earnings announcement will come around (about 3 ½ months from now). If IBM is trading anywhere near $160 at that time, I should be able to sell a 160 call with 3 weeks of remaining life for about $354, just like I sold one today. That alone would get about 75% of my initial investment back.
In any event, over the six-months that I might own the 21Apr17 calls, I will have many chances to sell new calls and hopefully collect much more time premium than I initially shelled out for the calendar spread. There may be times when I have to buy back expiring calls because they are in the money, but I should be able to sell further-out short-term calls at the same strike for a nice credit and whittle down my initial investment.
I also made this trade today:
Buy To Open 1 IBM 21Apr17 160 call (IBM170421C160)
Sell To Open 1 IBM 14Oct16 160 call (IBM161014C160) for a debit of $6.65 (buying a calendar)
This is the same calendar spread as the first one, but the sell side is the 14Oct16 series which expires a week before the announcement date week. If IV for the 21Oct16 series does escalate from its present 25 (as it should), I might be able to sell calls with a week of remaining life for a higher price than is available right now. I might end up with paying less than $473.50 for the original spread which sold the post-announcement 21Oct16 calls.
Tags: Calendar Spreads, Calls, diagonal spreads, Earnings Announcement, Earnings Option Strategy, Earnings Play, IBM, implied volatility, Monthly Options, Portfolio, Profit, Terry's Tips, thinkorswim, VIX, Volatility, Weekly Options