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9 Weeks to Better Options Trading: Special Situations: Earnings Reports, Takeovers, and Extreme Market Moves

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Veteran options trader Steve Smith breaks down special situations.

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Earnings Plays

Earnings are always tricky in that there are many moving parts that need to be gauged; what is expected, what the actual results are, what the options are pricing in, and what the reaction will be.

One can usually assume that implied volatility will decline immediately following an earnings report. For this reason, I always suggest using some type of spread when playing earnings, whether vertical, butterfly, or condor, as described in previous articles (see the list below), to offset a decline in IV. Also, it makes sense to keep the size of earnings-driven trades small as these are often speculative singular events in which you won't have time for a thesis to play out, or for a position to recover if you are wrong.

For example, Digital River (NASDAQ:DRIV) is set to report earnings on Thursday. The implied volatility of the May options is running around 55%, higher than the 30-day average of 41%, and also well above the 30-day historical volatility at 35%. Following the report, no matter what the results turn out to be, one can expect implied volatility to revert to the mean, or around the 41% level.
No positions in stocks mentioned.

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