Options Earning Season

3 Ways the Pros Evaluate Stock Targets During the Options Earnings Season – #2 is a Secret!

Options Earnings Season

Total Options volumes are surging to new records in 2021. For the first time in market history, the single stock option notional values have exceeded single stock share notional values during a full quarter. This dominant options activity makes it necessary for you to understand the daily messages emerging from that side of the fence. Avoiding these valuable signals place you at a significant disadvantage against those investors capable of reading them.

One such message appears during the options earnings season. Specifically, during an options earnings season there are several ways that the options market indicates the expected move in the stock price after the earnings announcement. While there’s a standard way to find these answers, this article reveals two additional methods used by the top experts in the world.

Before doing that, I’ll quickly explain a straddle option and introduce you to a normal distribution curve. Understanding these two concepts makes the options message that much more powerful.

What is a Straddle Option?

A “Straddle Option,” or just a “Straddle,” refers to the buying or selling of both the Call and the Put with the same Strike Price and the same Expiration. Here’s an example:
AAPL Straddle option strategy

The above Options Chain shows the AAPL options chain for the December 17th, 2021, expiration date.

While you can take the Calls and Puts on any strike, I chose the $150 Strike Price because that is the at-the-money (ATM) Strike Price. When an option trader refers to a “Straddle,” they generally mean the “ATM Straddle.”

If we buy the $150 Straddle, then we pay $4.04 for 1 Call and $3.96 for 1 Put. This is a total cost of $8.00 (For 1 contract it would $800).

The Normal Distribution Curve

Most people are familiar with the normal distribution curve, or “the Bell Curve.” The easiest example is often associated with test scores from a group of students. The center of a normal distribution curve (0 on the chart) marks the average score for the whole group. Then there is a mathematical approach to divide the test takers into segments using markers that are above and below the average (mean).

Marking the Curve

The normal distribution curve looks like this:

Options Use a Normal Distribution Curve

These markers (-3 to +3 on the chart) are specific: 34%, 47.5%, and 49.85% around the average. For example, “34%” means that 34% of the group fell in the range between 0 and 1, or 0 and -1.

On the chart, the markers refer to “standard deviations from the mean.” For example, “1” means “1 standard deviation from the mean.” However, they can easily refer to actual test scores.

Example

For example, assume the average test score was 81 and the standard deviation was 6. We can then change the -1, 0, and the 1 marker to test scores. The -1 and 1 markers are replaced by 75 and 87, which is 1 standard deviation above and below 81. We simply add and subtract 6 from 81.

Options Use a Normal Distribution Curve 2

This indicates that 68% (34 + 34) of the test scores fall between the -1 and 1 markers, or 1-standard deviation from the mean test score. The translation is that 68% of the test scores fall between 75 and 87.

Options Use a Normal Distribution Curve 3

Adds to 100%

Since the percentages under the curve must equal 100%, you can also “slice” the curve and say that 32% of the test scores are outside the 75 to 87 range (or outside a 1-standard deviation move). In other words, 16% of the test results represent the top scores above 87 and another 16% represent the lowest scores below 75.

Options Use a Normal Distribution Curve 4

Options and the Normal Distribution Curve

The Black-Scholes formula used for options pricing incorporates a normal distribution function. One output from this famous formula is the Implied Volatility, which helps investors measure the expected range of stock prices. More specifically, the Implied Volatility is the annual range of the stock depicted by a 1-standard deviation move.

The Option Premium is needed by the Black-Scholes formula to calculate an Implied Volatility. This connection between the Option Premium and the normal distribution curve provides the market's expectations of a stock price range. It’s a secret used by the elite options traders that I’ll show you in a moment.

For now, just try to remember the above charts. They will come in handy when I show you how the Top 1% translate the options message.

Let's start with the standard “Earnings Message” we get from the options market.

#1. Break-evens 

Generally, online options gurus and TV specialists describe the market’s expected stock price move for earnings as a percentage.

For example, “Target (TGT) has earnings next week. The market expects TGT stock will move approximately 5.9% after earnings.”

Options Earnings Season - TGT Straddle options strategy

To get that number, they use the following steps:

  • Look for the closest expiration that includes the earnings announcement, ideally the weekly option. Earnings are on November17th (arrow pointing to letter ‘E’ on chart), so we use the November 19th expiration.
  • Add the Puts and the Calls of the closest strike to the ATM Straddle. This would be the $260 strike.
  • Divide the ATM Straddle by the Strike Price to get the estimated percentage move for the earnings.

The ATM Straddle is $7.46 + $7.78 = $15.24. TGT stock price is $260.00.

This makes the answer $15.24 / $260.00 = 5.9%.

Price Range

You can also get a price range by adding/subtracting the straddle from the strike price.
In this case, the stock price range would be $15.24 above and below $260, or $244.76 to $275.24.

Easy enough.

This method was used a few times on TV years ago and quickly became the de facto way of estimating a stock’s move after earnings.

In a nutshell, it gives you the break-even prices for the straddle option. In other words, it tells you the stock prices where the buyer/seller of the straddle option make or lose no money.

Since options trading is a probability game, there is a more mathematical approach used by top professionals that adds to the analysis.

#2. The Power of 1.25 

Using the Options Chain, you can quickly approximate a 1-standard deviation expected move in the underlying stock price.

It varies slightly from what was done above:

  • Look for the closest expiration that includes the earnings announcement, ideally the weekly option.
  • Add the Puts and the Calls of the closest strike to the ATM Straddle. 
  • Multiply the ATM Straddle amount by 1.25.
  • Add/Subtract that from the Strike Price to get 1-standard deviation range in the stock price.

For example, Target (TGT) has earnings this coming week.

The TGT stock price is $260.02. This makes $260 the closest strike price.

Notice, the TGT November 19th $260 Calls cost $7.46.

And the TGT November 19th $260 Puts cost $7.78.

The makes the TGT $260 ATM Straddle option cost $15.24 (= $7.46 + $7.48).

Options Earnings Season - straddle option

We then use the 1.25 multiplier. $15.24 multiplied by 1.25 = $19.05.

Price Range

To create the price range, we add and subtract $19.05 from the strike price.

  • High Stock Price = $260.00 + $19.05 = $279.05.
  • Low Stock Price = $260.00 - $19.05 = $240.95.

This means that the 1-standard deviation range for TGT stock is $240.95 to $279.05.

You can then say:

“The market expects that the TGT stock price will fall between $240.95 to $279.05 on November 19th… 68% of the time.”

As stated earlier, the 1-standard deviation is the “Volatility” number everyone talks about with options. This exercise should help make that concept more practical.

The Check

To check our findings, we must remember this chart.

Options Use a Normal Distribution Curve 5

Recall, 1-standard deviation added and subtracted from the mean gives us 68% of the outcomes.  This means that 16% is left above and below those points.

If our estimated 1-standard deviation range for TGT is between $240.95 and $279.05, then it’s also fair to say that 16% of the outcomes should be above $279.05 and 16% will be below $240.95.

Options Use a Normal Distribution Curve 6

As stated earlier, the Black-Scholes formula uses the normal distribution curve function to make its calculations. One output from the formula is the probability of an option expiring In-the-money (ITM). This implies that the probability of being ITM for the $240.95 Puts (below $240.95) and the $279.05 Calls (above $279.05) is 16%.

To check that, we can go to the New Options Chain and press the blue “i” button next to Calls and Puts to get the following two charts that show the probability of each strike being ITM (“ITM”).

Options Earnings Season - TGT Call Options OTM

If we assumed there was a $279.05 Call option, then notice that the “ITM” number lines up relatively close to the 16% levels. If you do the same with the $240.95 Put option, you get the same result. Take a look here:

Options Earnings Season - TGT Put Options OTM

Again, the “ITM” is the probability that the option will be ITM at the expiration date. In English, “16%” means that there is a 16% chance of the stock price ending above the Call Strike Price or below the Put Strike Price.

Considering our normal distribution curve, this matches well with the statement:

“The market expects that the TGT stock price will fall between $240.95 to $279.05 on November 19th… 68% of the time.”


Not Just for Earnings

Keep in mind, you can make this calculation with or without an earnings event.

Ultimately, it’s the option premiums that dictate the 1-standard deviation range of the stock. The Option premiums are simply a function of supply and demand. This means that a greater demand for an option increases the Implied Volatility which increases the expected range of the underlying stock.

While the results won’t be exact because of some assumptions used in the Black-Scholes formula, it’s a great estimate and another factor for your analysis.

I encourage you to try it out.

#3. Leveraged Break-evens

The last way to get a sense of how the market is expecting the stock to move with earnings involves the use of the New Options Chain. More specifically, the focus goes toward the “RR$” columns you see below. 

Options Earnings Season - Risk Reward Breakeven Price

Risk-Reward Breakeven Price

“RR$” stands for Risk-Reward Breakeven Price, a new concept taught at OptionsGeek.com. The prices you see in the RR$ column on the New Options Chain are the expected stock prices at expiration that are priced into the corresponding options.

For example, with TGT at $260.02, the TGT November 19th $250 Puts cost $3.63 and have an RR$ of $237.09.

Options Earnings Season - How to Buy Put Option

The market has deemed that $237.09 is the stock price at expiration that would equally balance the potential risk of losing the premium vs. the reward of the potential payouts offered by that option. Another way of thinking about it… If you think TGT is going to $237.09, there is “No Edge.” To buy that $250 Put option with edge, you would need an expected price lower than $237.09.

The RR$ is calculated using the probabilities of the stock expiring ITM. These probabilities can be retrieved from the Black-Scholes formula (You can click on the blue circles with the ‘i’ to see these probabilities).

Finding Opportunity to Buy Options 

By default, most of the strikes on the New Options Chain are shaded. The unshaded areas are where the Top 1% in the world generally look for opportunity to Buy options. It’s where they find the best leverage.

By focusing on the RR$ in the middle of the unshaded range, you can gauge the stock price levels implied by the options market on a levered basis. 

In this example, the RR$ for the $252.50 Puts is $239.13. On the Call side, I averaged the RR$ for the $265 and $267.50 to get $281.04. Therefore, you can say:

"On a levered basis, the market is looking at a stock price range of approximately $239.13 and $281.04."


Options Signals

The earnings signals on TGT were as follows:

A.    Straddle => $244.76 to $275.24
This is where the risk-reward is balanced.

B.           1.25 => $240.95 to $279.05
The market believes the stock will land in between these prices 68% of the time.

C.   Leverage => $239.13 to $281.04
The Top 1% look for opportunity outside these levels.

These price levels can help you in two ways.

First, they can be used as a gauge to decide whether Buying or Selling Options fits your view on the stock.

For example, if you are comfortable buying at the lower price or selling the stock at the higher price, then selling options would be the better trade for you. If you think TGT can reach outside the Leverage levels, then buying options may offer a better risk-reward. 

And second, these prices can be used as markers to buy or sell the stock after the event.

Example

There are many more signals offered by the options market that are used by the top traders to guide their decisions. You place yourself at a significant disadvantage if you cannot read them.

Gain a better understanding of options and the mechanics behind them with the best options trading course on the market. You will learn to read the options flow in a way that tells a “story,” which makes it easier for you to profit.

Just like I did hear in FB:

If you want to learn how to do this yourself, take a look at this unbeatable offer that includes:

  • The Best Options Education available on the Market
  • Top Trading Ideas producing incredible returns.
  • 1-on-1 Coaching directly with Felix Frey.

One low price that absolutely cannot be beaten!

GREAT

TRADING IDEAS
REQUIRE

DATA

WINNING

PICKS

LEARN MORE

Learn More About Coaching

KENNETH P.


THIS IS A POWERFUL PROFITABLE TRADING SYSTEM!

Kudos to the OptionsGeek for making options clear and understandable! All the mystery surrounding which options to trade is thoroughly debunked, and traders are shown how to how to profit over time using mathematical edge. OptionsGeek provides a powerful proprietary tool — The New Options Chain — which contains important metrics like the Risk Reward Breakeven Price and the Options Margin of Safety that are available nowhere else. Somehow, the OptionsGeek has managed to follow that famous phrase: “Everything should be made as simple as possible, but not simpler.” (Einstein). This is what OptionsGeek provides. A simple yet incisive system of profitable trading by leveraging the power of options and managing risk and reward. It’s dynamic and very exciting!

Click to Join the Options Trading Newsletter
Options Earning Season

3 Ways the Pros Evaluate Stock Targets During the Options Earnings Season – #2 is a Secret!

Options Earnings Season

Total Options volumes are surging to new records in 2021. For the first time in market history, the single stock option notional values have exceeded single stock share notional values during a full quarter. This makes it necessary for you to understand the daily messages emerging from the options market. Avoiding these valuable signals places you at a significant disadvantage against those investors capable of reading them.

One such message appears during the options earnings season. Specifically, during an options earnings season there are several ways that the options market indicates the expected move in the stock price after the earnings announcement. While there’s a standard way to find these answers, this article reveals two additional methods used by the top experts in the world.

Before doing that, I’ll quickly explain a straddle option and walk you through a basic understanding of a normal distribution curve. A better grasp of these two concepts makes the message that much more powerful.

What is a Straddle Option?

 A “Straddle Option,” or just a “Straddle,” refers to the buying or selling of both the Call and the Put with the same Strike Price and the same Expiration. Here’s an example:
AAPL Straddle option strategy

The above Options Chain shows the AAPL options chain for the December 17th, 2021, expiration date.

While you can take the Calls and Puts on any strike, I chose the $150 Strike Price because that is the at-the-money (ATM) Strike Price. When an option trader refers to a “Straddle,” they generally mean the “ATM Straddle.”

If we buy the $150 Straddle, then we pay $4.04 for 1 Call and $3.96 for 1 Put. This is a total cost of $8.00 (For 1 contract it would $800).

A Normal Distribution Curve

Most people are familiar with the normal distribution curve, or “the Bell Curve.” The easiest example is often associated with test scores from a group of students. The center of a normal distribution curve (0 on the chart) marks the average score for the whole group. Then there is a mathematical approach to divide the test takers into segments using markers that are above and below the average (mean).

Marking the Curve

The normal distribution curve looks like this:

Options Use a Normal Distribution Curve

These markers (-3 to +3 on the chart) are specific: 34%, 47.5%, and 49.85% around the average. For example, “34%” means that 34% of the group fell in the range between 0 and 1, or 0 and -1.

On the chart, the markers refer to “standard deviations from the mean.” For example, “1” means “1 standard deviation from the mean.” However, they can easily refer to actual test scores.

Example

For example, assume the average test score was 81 and the standard deviation was 6. We can then change the -1, 0, and the 1 marker to test scores. The -1 and 1 markers are replaced by 75 and 87, which is 1 standard deviation above and below 81. We simply add and subtract 6 from 81.

Options Use a Normal Distribution Curve 2

This indicates that 68% (34 + 34) of the test scores fall between the -1 and 1 markers, or 1-standard deviation from the mean test score. The translation is that 68% of the test scores fall between 75 and 87.

Options Use a Normal Distribution Curve 3

Adds to 100%

Since the percentages under the curve must equal 100%, you can also “slice” the curve and say that 32% of the test scores are outside the 75 to 87 range (or outside a 1-standard deviation move). In other words, 16% of the test results represent the top scores above 87 and another 16% represent the lowest scores below 75.

Options Use a Normal Distribution Curve 4

Options and the Normal Distribution Curve

The Black-Scholes formula used for options pricing incorporates a normal distribution function. One output from this famous formula is the “Implied Volatility,” which helps investors measure the expected range of stock prices. More specifically, the Implied Volatility is the annual range of the stock depicted by a 1-standard deviation move.

The Option Premium is needed by the Black-Scholes formula to calculate an Implied Volatility. This connection between the Option Premium and the normal distribution curve provides the market's expectations of a stock price range. It’s a secret used by the elite options traders that I’ll show you in a moment.

For now, just try to remember the above charts. They will come in handy when I show you how the Top 1% translate the options message.

Let's start with the standard “Earnings Message” we get from the options market.

#1. Break-evens 

Generally, online options gurus and TV specialists describe the market’s expected stock price move for earnings as a percentage.

For example, “Target (TGT) has earnings next week. The market expects TGT stock will move approximately 5.9% after earnings.”

Options Earnings Season - TGT Straddle options strategy

To get that number, they use the following steps:

1. Look for the closest expiration that includes the earnings announcement, ideally the weekly option. Earnings are on November17th (arrow pointing to letter ‘E’ on chart), so we use the November 19th expiration.

2. Add the Puts and the Calls of the closest strike to the ATM Straddle. This would be the $260 strike.

3. Divide the ATM Straddle by the Strike Price to get the estimated percentage move for the earnings.

In our example, the ATM Straddle is $7.46 + $7.78 = $15.24. TGT strike price is $260.00.

This makes the answer $15.24 / $260.00 = 5.9%.

Price Range

You can also get a price range by adding/subtracting the straddle from the strike price.
In this case, the stock price range would be $15.24 above and below $260, or $244.76 to $275.24.

Easy enough.

This method was used a few times on TV years ago and quickly became the de facto way of estimating a stock’s move after earnings.

In a nutshell, it gives you the break-even prices for the straddle option. In other words, it tells you the stock prices where the buyer/seller of the straddle option make or lose no money.

Since options trading is a probability game, there is a more mathematical approach used by top professionals that adds to the analysis.

#2. The Power of 1.25 

Using the Options Chain, you can quickly approximate a 1-standard deviation expected move in the underlying stock price.

It varies slightly from what was done above:

1. Look for the closest expiration that includes the earnings announcement, ideally the weekly option.

2. Add the Puts and the Calls of the closest strike to the ATM Straddle. 

3. Multiply the ATM Straddle amount by 1.25.

4. Add/Subtract that from the Strike Price to get a 1-standard deviation range in the stock price.

For example, Target (TGT) has earnings this coming week.

The TGT stock price is $260.02. This makes $260 the closest strike price.

Notice, the TGT November 19th $260 Calls cost $7.46.

And the TGT November 19th $260 Puts cost $7.78.

The makes the TGT $260 ATM Straddle option cost $15.24 (= $7.46 + $7.48).

Options Earnings Season - straddle option

We then use the 1.25 multiplier.

$15.24 multiplied by 1.25 = $19.05.

Price Range

To create the price range, we add and subtract $19.05 from the strike price.

High Stock Price = $260.00 + $19.05 = $279.05.

Low Stock Price = $260.00 - $19.05 = $240.95.

This means that the 1-standard deviation range for TGT stock is $240.95 to $279.05.

You can then say:

“The market expects that the TGT stock price will fall between $240.95 to $279.05 on November 19th… 68% of the time.”

As stated earlier, the 1-standard deviation is the “Volatility” number everyone talks about with options. This exercise should help make that concept more practical.

The Check

To check our findings, we must remember this chart.

Options Use a Normal Distribution Curve 5

Recall, 1-standard deviation added and subtracted from the mean gives us 68% of the outcomes.  This means that 16% is left above and below those points.

If our estimated 1-standard deviation range for TGT is between $240.95 and $279.05, then it’s also fair to say that 16% of the outcomes should be above $279.05 and 16% will be below $240.95.

Options Use a Normal Distribution Curve 6

As stated earlier, the Black-Scholes formula uses the normal distribution curve function to make its calculations. One output from the formula is the probability of an option expiring In-the-money (ITM). This implies that the probability of being ITM for the $240.95 Puts (below $240.95) and the $279.05 Calls (above $279.05) is 16%.

To check that, we can go to the New Options Chain and press the blue “i” button next to Calls and Puts to get the following two charts that show the probability of each strike being ITM (“ITM”).

Options Earnings Season - TGT Call Options OTM

If we assumed there was a $279.05 Call option, then notice that the “ITM” number lines up relatively close to the 16% levels. If you do the same with the $240.95 Put option, you get the same result. Take a look here:

Options Earnings Season - TGT Put Options OTM

Again, the “ITM” is the probability that the option will be ITM at the expiration date. In English, “16%” means that there is a 16% chance of the stock price ending above the Call Strike Price or below the Put Strike Price.

Considering our normal distribution curve, this matches well with the statement:

“The market expects that the TGT stock price will fall between $240.95 to $279.05 on November 19th… 68% of the time.”

Not Just for Earnings

Keep in mind, you can make this calculation with or without an earnings event.

Ultimately, it’s the option premiums that dictate the 1-standard deviation range of the stock. The Option premiums are simply a function of supply and demand. This means that a greater demand for an option increases the Implied Volatility which increases the expected range of the underlying stock.

While the results won’t be exact because of some assumptions used in the Black-Scholes formula, it’s a great estimate and another factor for your analysis.

I encourage you to try it out.

#3. Leveraged Break-evens

The last way to get a sense of how the market is expecting the stock to move with earnings involves the use of the New Options Chain. More specifically, the focus goes toward the “RR$” columns you see below. 

Options Earnings Season - Risk Reward Breakeven Price

“RR$” stands for Risk-Reward Breakeven Price, a new concept taught at OptionsGeek.com. The prices you see in the RR$ column on the New Options Chain are the expected stock prices at expiration that are priced into the corresponding options.

For example, with TGT at $260.02, the TGT November 19th $250 Puts cost $3.63 and have an RR$ of $237.09.

Options Earnings Season - How to Buy Put Option

The market has deemed that $237.09 is the stock price at expiration that would equally balance the potential risk of losing the premium vs. the reward of the potential payouts offered by that option. Another way of thinking about it… If you think TGT is going to $237.09, there is “No Edge.” To buy that $250 Put option with edge, you would need an expected price lower than $237.09.

The RR$ is calculated using the probabilities of the stock expiring ITM. These probabilities can be retrieved from the Black-Scholes formula (You can click on the blue circles with the ‘i’ to see these probabilities).

Finding Opportunity to Buy Options

By default, most of the strikes on the New Options Chain are shaded. The unshaded areas are where the Top 1% in the world generally look for opportunity to Buy options. It’s where they find the best leverage.

By focusing on the RR$ in the middle of the unshaded range, you can gauge the stock price levels implied by the options market on a levered basis. 

In this example, the RR$ for the $252.50 Puts is $239.13. On the Call side, I averaged the RR$ for the $265 and $267.50 to get $281.04. Therefore, you can say:

"On a levered basis, the market is looking at a stock price range of approximately $239.13 and $281.04."


Options Signals

The earnings signals on TGT were as follows:

A.    Straddle => $244.76 to $275.24
This is where the risk-reward is balanced.

B.           1.25 => $240.95 to $279.05
The market believes the stock will land in between these prices 68% of the time.

C.   Leverage => $239.13 to $281.04
The Top 1% look for opportunity outside these levels.

These price levels can help you in two ways.

First, they can be used as a gauge to decide whether Buying or Selling Options fits your view on the stock.

For example, if you are comfortable buying at the lower price or selling the stock at the higher price, then selling options would be the better trade for you. If you think TGT can reach outside the Leverage levels, then buying options may offer a better risk-reward. 

And second, these prices can be used as markers to buy or sell the stock after the event.

Example

There are many more signals offered by the options market that are used by the top traders to guide their decisions. You place yourself at a significant disadvantage if you cannot read them.

Gain a better understanding of options and the mechanics behind them with the best options trading course on the market. You will learn to read the options flow in a way that tells a “story,” which makes it easier for you to profit.

Just like I did hear in FB:

If you want to learn how to do this yourself, take a look at this unbeatable offer that includes:

  • The Best Options Education available on the Market
  • Top Trading Ideas producing incredible returns.
  • 1-on-1 Coaching directly with Felix Frey.

One low price that absolutely cannot be beaten!

GREAT

TRADING IDEAS
REQUIRE

DATA

WINNING

PICKS

LEARN MORE

Learn More About Coaching

KENNETH P.


THIS IS A POWERFUL PROFITABLE TRADING SYSTEM!

Kudos to the OptionsGeek for making options clear and understandable! All the mystery surrounding which options to trade is thoroughly debunked, and traders are shown how to how to profit over time using mathematical edge. OptionsGeek provides a powerful proprietary tool — The New Options Chain — which contains important metrics like the Risk Reward Breakeven Price and the Options Margin of Safety that are available nowhere else. Somehow, the OptionsGeek has managed to follow that famous phrase: “Everything should be made as simple as possible, but not simpler.” (Einstein). This is what OptionsGeek provides. A simple yet incisive system of profitable trading by leveraging the power of options and managing risk and reward. It’s dynamic and very exciting!

Click to Join the Options Trading Newsletter