When is the Best Time to Open Options Positions During Earnings Season? Unveiling the Secrets to Boost Your Winning Rate

Betting on earnings with options: when is the best time to enter? This question troubled me for a long time.

Entering too early means the news is unclear, possibly leading to a wrong bet and wasting time value. Entering too late means the option's implied volatility (IV) is too high, causing a premium on the option, and any IV adjustment makes it a loss.

Today, I want to discuss in detail how to open positions during earnings season for better winning chances, using Tesla's recent earnings as an example.

1. Betting on Options Often Results in Losses Due to Ignoring IV
Why do people often lose money during earnings season? This boils down to three Greek letters: Delta, Vega, and Theta. These represent how stock price, implied volatility, and time affect the option premium, respectively.

From the buyer's perspective:
- Delta: When the stock price rises, Delta rises, increasing the option premium.
- Vega: When implied volatility (IV) rises, Vega rises, increasing the option premium.
- Theta: With time passing, Theta decays, reducing the option premium.

In summary, changes in Delta and Vega are positively correlated with the option premium, while Theta always reduces the option premium.

Thus, if the stock price isn’t strong, IV must rise to cover the losses from stock price and time decay. Conversely, if IV drops, the stock price must rally significantly to cover the volatility and time decay losses.

However, the reality is: IV dropping sharply after earnings is a certainty, while the stock rising after earnings is a rare event. Under the dual decline of Vega and Delta, it’s hard for the option premium to recover.

Tesla reported earnings on April 23. The chart below shows the change in IV of a particular option before and after earnings. Two conclusions can be drawn:

1. Tesla’s IV is significantly high before earnings.
- You can compare IV with historical volatility. Historical volatility is calculated based on the average volatility over the past N days and can be seen as the moving average of IV.
- If IV is above the historical value, it’s considered high; if below, it’s low.
- In the chart, this option’s IV was about 16% higher than the historical value the night before earnings were announced.

2. Tesla’s IV drops sharply after earnings.
- Within just one day after earnings, IV dropped by 16%, returning to historical averages.

Why does IV plummet?
1. IV represents market expectations. Before earnings, the information is unknown, and the market has expectations about the stock price. After earnings, the information is known, and expectations are fulfilled.
2. IV can be manipulated by market makers. Especially for popular stocks like Tesla, where many people trade, market makers can inflate IV to trap retail investors.

A drop in IV will cause the option premium to fall. To avoid losses, the stock price must rise significantly.

- You can use a formula to calculate: Stock price rise = (Change in IV * Vega * 100) / Delta / Current stock price.

- Plugging in the relevant numbers, you can calculate that the stock must rise by at least 5.32% for this option to break even; any rise above 5.32% could be profitable.

What does a 5.32% rise look like? Below is a chart of Tesla’s stock performance the day after earnings since 2022.

Out of nine earnings seasons, only three times saw positive gains, while the other six were negative.

Thus, while the IV drop is a certainty, the stock rising after earnings is rare. Under the double decline of Vega and Delta, it’s no wonder options struggle to recover.

By now, you might have noticed that I haven’t mentioned when exactly to enter for higher winning chances.

That’s because early entry leads to time decay, and late entry leads to IV crush. These are facts, not problems, and they are unavoidable and unchangeable.

So, what truly improves the winning rate? Understanding the underlying stock is more important than timing.

Yes! More important than the timing of the investment is your understanding of the stock. You need to have an answer in your mind regarding the stock's direction and magnitude before determining your strategy and timing based on the current Delta and Vega.

If you have a clear direction and sufficient magnitude, even with an IV halved, options can still be profitable. In other words, as a buyer looking to profit during earnings season, you must be certain that the stock's move will cover the IV crush.

Alright, that’s all for today’s content. The article is a bit long, so thanks for reading this far. I hope it helps.