James Ramelli

A 5 Step Plan for Trading Earnings

By James Ramelli,

While many traders tend to avoid trading earnings due to the high level of gap risk there can be some great opportunities for a trader who is using a systematic and methodical trading plan. Here we will go over 1 trade setup in NVIDIA Corporation (NVDA) using a plan for earnings trade analysis ahead of their May earnings release. The plan has only 5 steps and is a great way for traders to analyze and trade options spreads in stocks ahead of earnings.

The NVDA Setup:

NVIDIA Corporation (NVDA) stock was trading around $35.55 going into the release of earnings. To determine the suitability of this symbol for an options trade we will look at 5 different key metrics.

  1. Historical Movement
  2. Implied Movement
  3. Measured Move Targets
  4. Chart
  5. Trade Risk and Reward

Each of these key points will give us useful information on how to trade the symbol or if we want to trade it at all. Let’s break down all of these key data points for NVDA as they set up before the release of the earnings report.

Historical Movement: This is a measure of how much the stock has moved in the past. To make sure we are using the most relevant historical movement data we are only going to look at how the stock moved around the release of earnings. Catalyst movement can be very different from underlying trend so we only want to focus on historical movement on earnings day. The historical movement record can also show us what the stock tends to do on earnings day and how much we could expect it to move this time around.

In NVDA we can see that the stock had rallied on earnings day 8 of the past 11 quarters with an average move of 6.73%. This tells us that in general NVDA tends to rally after earnings and that the average magnitude of its post earnings movement is 6.73%. We can use this information to determine how fairly priced options are ahead of an earnings event. We do this by comparing the historical movement average to the implied move for this release.

Implied Move: To calculate the implied move a trader can use a simple trick. Simply add the price of the at the money calls to the price of the at the money puts in the most recent expiration to get the at the money straddle price. This straddle price tells a trader the market expectations for movement in the underlying by expiration.

Ahead of the most recent earnings release in NVDA the weekly at the money straddle was trading around $3.10. With stock trading at $35.55 this means that the options market is implying roughly 8.7% in movement by options expiration that week. Since we know that NVDA moves 6.73% on average historically we know that this implied move is well within the realm of possibility. Using this implied move we can project targets for NVDA on expiration.

Measured Move Targets: Using the implied move we can calculate expected closing prices for the stock. To do this we simply add the implied move to the stock price to get an upside target and subtract it from the stock price to get a downside target.

Upside Target = $35.55 + $3.10= $38.65
Downside Target = $35.55 - $3.10= $32.45

Once we have these targets we need to confirm the directional bias we see in historical movement using the stock’s chart.

Chart: The chart shows us what the underlying trend is in the security. While catalyst movement can be different from underlying trend it can be useful for a trader to see what price action and general trend is like in a security going into earnings. Below is the pre earnings chart setup in NVDA.

We can see that the stock was in a clear up trend since last earnings and the near term price action is not indicating the market thinks NVDA will sell off on earnings. With the very bullish historical movement bias in mind this chart confirms a bullish setup in NVDA going into earnings.

 Trade Reward and Risk: Once we confirm the bearish setup in the stock and have a downside target calculated we want to select an options trade that gives us the best potential return for invested capital. Spreads are generally favored as they lower overall risk in the position and negate some of the effects of a likely drop in implied volatility after the release of earnings. Using the calculated upside target of $38.65 we can look for an options spread.

Trade: Buying the NVDA May 37-39 Call Spreads for $0.59
Risk: $59 per 1 lot
Reward: $141 per 1 lot
Breakeven: $37.59

This gives a trader exposure to a move higher in NVDA and offers a reward to risk setup of better than 2-1. Let’s see how the trade performed.

After NVDA reported earnings the stock ripped higher and closed at $44.33 at expiration meaning this spread settled at dull value of $2.00 more than tripling the trader’s money in 1 week.

While not every earnings trade works this well a trader has a much better chance of success if they use a plan like this to analyze trade setups before executing them. All traders who are trading earnings should think about these 5 key points before they take their next earnings trade.

This presents tremendous opportunities for traders to place low risk, high reward trades using weekly options.

Some of our favorite trade setups are for company earnings reports – these types of catalyst events offer tremendous opportunities for traders to place low risk, high reward trades using weekly options.

The Special Offer

We use the exact techniques he teaches in his best-selling course, Earnings for the Taking: Trading Plan Every Trader Must Have On Demand, using the same methods used by market makers on the exchange floor. We employ charting, technical and fundamental analysis, and the stock movement being implied by the option market. In the Earnings Workshop, we will take you through his HIMCRRBTT Trading Plan and explain how professional traders trade catalyst events.

Click Here to Access the Workshop!


James Ramelli

James Ramelli is a trader and options educator at AlphaShark Trading, where he actively trades futures, equity options, currency pairs and commodities. As one of the moderators of the Live Trading Room, Ramelli educates members on strategies, trade setups, and risk management while trading his own capital.

Ramelli regularly appears on Bloomberg TV, BNN, and CBOE TV, in addition to writing a weekly column for Futures Magazine and being featured in CME Group’s OpenMarkets as a guest contributor.

Ramelli holds a B.S. in Finance with a concentration in Derivatives and Financial Engineering from the University of Illinois at Urbana-Champaign.