Earnings — company results. Here something happens that at first seems absurd: you can be right that a company will report good results, watch the stock rise after the announcement… and still lose money on your option. How can that be? Let’s look at what you need to keep in mind when trading around earnings.
In options you’re not trading direction alone
The answer to that paradox is simple: in options you’re not only trading direction. You’re also trading the premium, the volatility, time and expectations. All at once.
Before results, the market already knows something might happen. It doesn’t know what, but something will: the company can surprise, disappoint, or raise or lower its guidance for the coming quarters. And the stock can move sharply.
The big trap: the IV Crash
The IV Crash is the sharp drop in implied volatility right after the event. Before results there’s uncertainty; afterwards, the event has already happened: we now know the published numbers, how the market reacted and what the company expects for the coming months. That uncertainty disappears all at once.
And when implied volatility falls, so does the value of options. That’s why, even if you’re right about the direction, you can lose money.
The right question at earnings
Here’s the key. At earnings it’s not enough to ask whether the stock will go up or down. The question you have to ask is:
Will it move more or less than what the market is already pricing in?
Because options are already incorporating that expected move. That expected move doesn’t tell you the direction (you don’t know whether it’ll be up or down), but it does give you an idea of how much movement the market is paying for.
Buying and selling: neither is free
- Buying calls before results can be expensive: you pay inflated premiums and, if the move doesn’t beat what’s priced in, you lose even when you’re right
- Selling options is dangerous too: premiums are high for a reason — the market expects a move. If you sell premium and there’s a big gap, you can suffer a lot
Buying options before earnings isn’t good in itself, nor is selling options free money. It all depends on the expected move, the volatility, the premium and the maximum risk of the strategy.
The 5 things to check before trading earnings
Pre-earnings checklist
The exact date of the event — it seems obvious, but it’s the first thing to check
Your expiration — does it fall before or after the event? It’s not the same; the calendar can completely change the trade
Implied volatility — if it’s already high, the premium will be higher. Buying, you pay it; selling, you collect it, but you take on the risk of a big move
The expected move — how much movement the market is pricing in. If it expects a huge one, the stock will have to move a lot for a bought option to pay off
The maximum risk — knowing how much you can lose BEFORE opening, not after. Buying, the risk is the premium; selling or with spreads, understand your maximum loss and in which scenario it appears
Conclusion
Take away this idea: at earnings, getting the direction right isn’t enough. You have to get the move right relative to what the market was already expecting. The IV Crash makes a call lose value even if the stock rises, because once the uncertainty disappears the premium deflates. If you want to go deeper into how volatility moves option prices, there’s the article dedicated to implied volatility and the IV Crash. And remember: this completely changes the way you look at options.
