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High Probability Iron Condor Earnings Trade in Netflix

Started by Michael Gonsalves, Jan 27, 2024, 04:15 PM

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Michael Gonsalves

According to an article in CNBC (link), the historical price movements of Netflix post the last five earnings events reveals a trend, namely, that most earnings-related shifts are typically confined within a 10% range. However, there are outliers like the 13% move on Oct. 19, 2022 and the 16% move on Oct. 19, 2023. These outliers show Netflix's inherent volatility.

It is also stated that the price movement after earnings in January of the previous year was recorded at 8.5%. This historical context provides insights into the potential magnitude of market reactions following the upcoming earnings announcement.

One can take advantage of the increase in implied volatility (IV) which causes an increase in the prices of options expiring shortly after the event. Once earnings are announced the IV (implied volatility) of the options declines forcefully. This is instantly reflected in options pricing on the following day after earnings, and options lose all this inflated juice thereby dropping drastically in value. This is also known as "IV Crush".

The trade recommended is an "Iron Condor". An earnings iron condor Selling an iron condor is an options trading strategy where you simultaneously sell out-of-the-money call spreads and put spreads. Since you are selling spreads (instead of selling naked calls and puts, your risk and reward are both defined at the time of entry).

To construct this trade, a trader can sell a put spread of $485 (current price) – $38 (expected move) on the expectation that NFLX will not drop below $447. To add some more buffer to this, the trader could sell a $435 put option and buy a $420 put option at the same time (thereby constructing put spread side of the trade).

On the same logic, the call spread can be $485 (current price) + $38 (expected move) is $523. We could add some more buffer to this and sell a $535 call option and buy a 540 call option simultaneously.

Trade Structure and Analysis:

SELL -1 NFLX 535-540 C\u002F435-430 P Iron Condor CREDIT (also max profit): $140 MAX LOSS: $360 Trade

Execution: These post-earnings trades are quick. Traders put them on 1 to 2 hours before the market close on the day earnings are about to be announced. This maximizes the premium one will capture on the trade. You may notice that the premium you are receiving goes up the longer you wait to put on this trade.

Note that the put side has a 88% probability of success and the call side has approximately 80% probability of success. Those are very good odds. However, as is the nature of high probability trading, the risk is higher than the max profit. So, we need to have clearly defined risk-reward targets for this trade.

It is also stated that these trades are high probability trades and so 8 out of every 10 trades are expected to become winners. However, there must be a pre-determined stop loss.