Anatomy of a trade into earnings starring Wells Fargo

There are many traders that choose to position ahead of an event like an earnings report hoping to catch a nice move. One of the simplest methods is to use Options to make a directional event (own a Call/Call spread or Put/Put spread).

In the case of $WFC I have elected to simply buy Jan 35 Calls to position for an upside move:

WFC_Jan_35_CallNote the volume into the close.

Here are the some benefits of this approach:

  • Risk is defined. What I paid for the Calls is all I can lose
  • No cap to an upside move
  • Can hedge in after hours or pre-market with stock to go more Delta neutral if there are gains that I want to lock in
  • If into market hours after the event, can then create a Call Spread if appropriate

So, what happens if the stock pulls back? Here are a few scenarios that can play out:

  • Stock pulls back 3% after the event
  • The Implied Volatility (IV) goes poof so the Call value will diminish quickly
  • If the pullback is met with dip buyers, I can choose to sell Puts (to attempt to cover cost of the Calls, thus creating a Risk Reversal) to play for a bounce
  • If the bounce does occur, can then sell upside Calls to create a Call spread and use these proceeds to buy back the short Puts if prudent to do so

Just a few thoughts on what the tactical work can be after an event – after the reaction.

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