Earlier, Dan posted a thorough preview of Procter & Gamble’s Q4 earnings due tomorrow morning. Implied vol in the name has creeped up into the event but is still way below levels seen over the past year:
That means directional views can be expressed into the event at fairly cheap premium levels. But we want to take that another step and look detail trade ideas that help finance that view and make it even cheaper…
The weekly options that capture tomorrow’s earnings are implying about a $2.35 move in either direction before Friday’s close or about 2.5% of the underlying. That can help inform choices in strikes where we can use the difference in implied vol in the weeklies to help finance directional views out a couple of months. The idea here is to sell a call or put at the implied move levels and buy a call or put inside that (closer to the money) in those directions in October.
So let’s go to the trade ideas to show how this can be done (note the strike differences):
Bullish: PG ($86.50) Buy the Aug5th weekly/ September 89/87.5 vertical calendar for 1.00
- Sell 1 Aug5th weekly 89 call at .30
- Buy 1 Sept 87.5 call for 1.30
Rationale – This creates a vertical spread for a dollar that can be worth up to 1.50 if the stock is above 89 on this Friday’s expiration. But the 89 calls expire on Friday’s expiration and the September calls obviously don’t. So ideally you would be looking for PG to be higher on earnings, but not a move greater than the implied move for maximum gains. If the stock does move higher but not substantially above 89 this week, the September call will be worth more, while the call expiring this week becomes worthless. The short call can then be closed or left to expire worthless and the September call can be further spread by selling an upside call in that month, creating a same month vertical for next to nothing. Remember, the implied move is about 2.35, which would put the stock just under that 89 strike. That’s the ideal situation. If the stock is lower than 89 but still higher than where it is now, that’s also good as this trade is long deltas. If the stock goes nowhere this trade will also be fine. If it goes up massively above 90 that’s fine too as it will still be profitable, but the sale of the 89 weeklies puts a cap on those profits if that happens this week. Where this trade would lose money is if PG stock is down on earnings as the .30 sold in the weeklies would not be enough to make up for losses in the September call. But that max that can be lost on a big downside move is limited to 1.00, much less than the implied move itself.
OK, that’s for those looking for upside in PG, what about a bearish trade idea?
Bearish: Buy the PG ($86.50) Aug5th weekly/ September 84/85 vertical put calendar for .80
- Sell 1 Aug5th weekly 84 put at .36
- Buy 1 August 85 put for 1.16
Rationale – Again, in the put version the ideal situation is a move in line with the implied move. In that case the stock would be just above the short weekly strike of 84. If it moves within that but still to the downside the 84 weekly puts can expire worthless and the September puts are well set up to continue as a vertical put spread by selling a lower strike Sept put. A move much lower this week and money can’t be lost, but it can max out at 1.00 (the width between 85 and 84) so this is not a “home-run” trade idea, simply one where the stock moves less or in-line than implied. (it can become a “home-run” after this week’s expiration) The situation where it loses money is a move higher in the shares this week, but again, the most that can be lost is what’s paid for the entire structure, .80 cents.
So in both cases, this is defined risk, with the opportunity to continue the position well past this week on follow through moves. The pumped weekly options that capture earnings, combined with knowledge of the implied move levels allows for a way to finance directional positions for much less risk than the implied move itself, and high probability of success if the direction of the earnings move is correct.