The earnings season is a goldmine for options traders, as it presents numerous opportunities to capitalize on significant price swings and surges in implied volatility, thereby securing a profit, all while employing strategies with a defined risk profile. Specifically, calendar spreads can be a strong choice for executing successful earnings plays, a strategy that’s ideal for intermediate traders seeking to capitalize on volatility.
Our guide on calendar spreads will show you how to set up the strategy around an earnings report or announcement, how they work to secure a profit, and how to effectively manage the trade as the earnings date comes and goes. Earnings plays with calendar spreads can offer investors and traders a strategic edge due to their flexibility, potential for high returns, and their defined risk profile.
Keep reading to find out how you can capitalize on quarterly reports using calendar spreads to your advantage!
Understanding Earnings Volatility
To fully understand why the calendar spread can be so effective for plays around earnings reports, you first need to know what the market conditions are like when a company makes it known to the public that they’re getting ready to release data on their financials.
What Happens Around Earnings
Earnings season is a time of uncertainty for traders. Even if the general consensus is that the report is going to be either good or bad, there is still no telling where the stock prices are going to go because there is a chance that the general consensus among investors could be wrong. It is never until the company announces its financial state with the hard numbers that traders and investors can know for certain the trajectory of the stock price.
Characteristics of the Market Around Earnings
- Major Price Movements: As a result of this uncertainty, earnings season is characterized by sudden price movements that can move both up and down.
- Spikes in IV: There are also volatility spikes that come from the uncertainty of which way the price swings could be going.
- Increased Demand: From the perspective of the traders or investors, this can lead to a lot of speculative traders and hedging, which means that there’s an increased demand for options, further adding to the higher levels of IV and big price swings.
- Adjustments by Market Makers: These groups that manage market liquidity by ensuring that there is enough buying and selling activity going on will typically adjust prices to reflect the higher demand and increased risk that comes during earnings season.
We would be remiss if we didn’t mention implied volatility crush (or IV crush), which happens right after the earnings data is released to the public. It is the major drop off of implied volatility as the uncertainty around the potential price movement clears up once the direction and magnitude of the market movement is more well-known. IV crush can have a major effect on options prices, resulting in a big loss for buyers and delivering major gains for sellers.
Why It Matters
Timing and implied volatility are critical for the success of an earnings trading strategy—it’s all about getting in at the right time to ride the rise in IV and exiting at the right time to either avoid IV crush or to use the phenomenon in your favor. We recommend entering trades on the short leg when IV is elevated or on the long leg when IV levels are more subdued.
- Entering on Short Leg—This is the segment of a multi-leg options strategy where the trader sells an options contract in an effort to profit from the price either staying stable or declining.
- Entering the Long Leg—Traders are buying an option with the intent of limiting risk of customizing potential returns instead of buying or selling a single option.
When you’re planning a strategy that profits from the IV levels going into an earnings report or announcement, understanding how timing and IV work together hand-in-hand can lead to a better understanding of the markets and can set a trader up for success by way of securing a profit.
Real-World Example
Just about any stock you’re dealing with in the options market is bound to experience big price movements and spikes in IV going into the earnings season. Let’s take a look at an earning trading strategy that could potentially happen in real life, where earning volatility can be used to the trader’s advantage.
Let’s say you’re trading Apple or Netflix stock and there is a quarterly earnings report on its way. You’ll see a spike in IV as there is an increased demand for options, so traders can make speculative moves or set up hedges for their current investments. On top of the increased activity with these stocks, there is uncertainty because traders aren’t completely sure if the earnings report for the company will be good or bad. The increased activity and uncertainty led to a significant jump in implied volatility.
To take advantage of these conditions, traders who are setting up an earnings trading strategy will want to enter the spread about a week or less before the announcement to get the most out of the heightened market volatility around the Apple or Netflix stock.
Calendar Spreads 101
Also known as “time spreads” or “horizontal spreads,” the calendar spread in options trading is the simultaneous purchase and sale of options contracts that focus on the same underlying asset, but that come with different expiration dates. The purpose of using this strategy is to make a profit from the price movement difference between the two options contracts. In many cases, traders are taking advantage of changes in IV and time decay to chase their profits.
What is a Calendar Spread?
Calendar spreads can have a directional bias, but they can also be used by traders who might have a neutral stance on the market. The spread is formed by buying a long-dated call or put option, while also selling a short-dated option of the same type (call or put). The strike prices will be the same, but the expiration dates are different, as seen with the long-dated and short-dated options being used.
A calendar spread during earnings ultimately allows the trader to profit when the price of the underlying asset stays stable near the strike price of the short-term option. It leads to the short-dated option to lose value because of time decay. On the other hand, the option with the longer date keeps its value through the process.
Why Calendar Spreads Work for Earnings Plays
The main driver of using a calendar spreads around the time of an earnings report release is that investors can potentially profit from the expected changes in volatility going into the announcement and coming out from it, but that is a general, simplified way of looking at things. There are several other reasons why these spreads are so effective around these events.
- Volatility Differential: IV skew is the difference in IV between options with different strikes, but the same expiration date. The volatility differential that is used with earnings plays is caused by the trader selling the front leg when there’s high IV and buying the back leg when there’s lower IV.
- Time Decay Advantage: There is also the benefit from theta decay on the short leg of the spread, which actually works in the trader’s favor as the contract draws closer to the expiration date.
- Controlled Risk: With the calendar spread, the maximum loss is limited to the initial debit that the trader pays for entering the spread. This move, at least compared to others, is a much less risky strategy, and it serves the trader better around earnings than buying and selling options outright ever could.
- Directional Bias or Neutral: Perhaps one of the nicest parts of the calendar spread is the fact that they can be used for directional plays as well as for situations where traders have a neutral market outlook.
For more information on implied volatility and how it tends to spike going into earnings and then wane coming out the other side, we’d encourage you to check out more on IV basics for a richer understanding.
Choosing the Right Earnings Setup
Traders who are interested in successfully trading options around earnings season will need to know the ideal conditions for entering the trade and then have a good idea of which tools they should be using to monitor these positions effectively. Let’s take a look at some of the best practices you could be applying to choose the right earnings setups that can secure respectable returns.
Ideal Conditions
- Upcoming Earnings Date: The ideal entry for a volatility play using a calendar spread is anywhere from one day to seven days before the expected release of the earnings report.
- Elevated Short-Term Implied Volatility: Options prices will usually inflate due to uncertainty before an earnings announcement, and this higher IV can be beneficial for selling options strategies because the premiums are higher in value than usual. The short leg of the spread benefits from a rise in IV, so this short-term expectation is ideal for the setup.
- Moderated Long-Term IV: It is key for traders to make sure that the back-month IV remains steady for the longer leg of the spread. The longer leg benefits from steadiness in terms of price movements and IV levels, expecting to retain its value over time.
Ticker Screening Tips
As a trader who wants to secure a profit from trading around earnings season, you’ll want to be using tools like Options AI, ThinkorSwim, or Market Chameleon to track IV levels throughout the entire process. Depending on the platform they’re using, traders can have access to the following tools for enhanced profits around earnings:
- Earnings Calendars: Track information on projected earnings impact, historical earnings-driven price movements, and conference call times so you can effectively track both past and upcoming earnings events for the US companies you’re trading.
- Backtested Strategies: Traders can access data on average returns and win rates for different earnings options strategies. They can check on this information using different time frame combinations for perspective. Traders learn of the effectiveness of each strategy by looking at past examples that trace historical performance through time.
- Earnings Option Strategy Screeners: This tool lets traders compare implied moves with historical examples from the past of past moves that traders have made and their results. It’s a helpful resource to find out times where options might have been mispriced in the past.
Once you have access to these kinds of tools, using resources like Market Chameleon or ThinkorSwim, traders are more than ready to take on calendar spread earnings steps head-on. For a better understanding of how some of these tools can enhance the experience, we’d encourage you to check out earnings calendars and how they can prepare a competent earnings setup.
Step-by-Step—Building a Calendar Spread Earnings Trade
It’s earnings time again. The next quarterly report is coming out for Apple (AAPL), and you’d like to make some money by trading volatility around this announcement, but where is one to begin? We have outlined a step-by-step guide to help you understand where you can start and build your calendar spread earnings strategy from there. Check out how to get set up and see your spread through to a profitable end.
Example Ticker: Apple (AAPL)
Selecting Your Strike Prices
- Use at-the-money strikes (ATM) when you’re feeling neutral on the market direction
- Use slightly out-of-the-money (OTM) when you have a lean one way or the other on market direction (bearish or bullish bias)
Selecting Your Expiration Dates
- Selling Options: The front leg has an expiration date that happens right after earnings, but the contract is active for about a week going into the announcement.
- Buying Options: The back leg of the spread consists of a monthly option that has an expiration date that kicks in about three to four weeks after the earnings announcement has come and gone.
Position Sizing & Risk
The general rule of thumb with position sizing in trading (no matter what kind of trading you’re doing) is to never use any more than 1-2% of your available capital on any position you take. The basic principle is to not use any more capital than you can afford to lose. For some perspective, a typical calendar spread’s debit can cost between $1 and $2.50.
Managing the Trade
Now that you’re aware of how to set up the spread in preparation for the earnings report, let’s delve into how you manage the trade throughout the week leading to the announcement and afterward, when the uncertainty begins clearing up after the report has been made public.
Before Earnings
The biggest takeaway with calendar spreads and earnings is to avoid same-day entry. You miss out on the bigger impacts that IV can have on the stock prices, and there is a tendency with same-day entry for the spreads to get more inefficient, which works against the trader or investor.
Best Times to Enter the Spread
Traders should get into a calendar spread about a week before the announcement on the longer end or a day before on the shorter end. Some people say that 2-5 days before is ideal, while others tout 1-7 days. It depends on your risk tolerance, time horizon, and personal trading style.
On Earnings Day
The earlier that you can close out the trade on earnings day, the better because this can help you to avoid sudden upward or downward shifts between the stock’s closing price one day and its opening price the next day (gaps).
This cautious approach isn’t for everyone, but it can help traders avoid unexpected surprises that come from a negative earnings report. Taking this safe route might have you sacrificing some potential profit if everything works out, but it can help greatly with capital preservation and risk management in the event the market goes against your position.
When to Lock in Profits
Another good rule of thumb with what to do with the calendar spread on the day of the earnings announcement would be to lock in your profits early if the short leg of the spread has decayed considerably. You see this move a lot with traders who are using short OTM options, and the time value has significantly depreciated.
Post-Earnings IV Crush
After the earnings announcement has come and gone, IV will begin to go down because a lot of the uncertainties about how the report would go over with the public have passed. This will have a big impact on the front leg of the spread because a lot of the inflated value this leg had before will dissipate quickly with the uncertainty giving it that “value” passing away.
Now, let’s look to the other side of the spread: the long leg. Traders have to take the time to evaluate if the long leg’s premium justifies them continuing to hold the spread. Combining this with the IV crush considerations for the short leg can give traders a good idea if they should exit the spread early on to see it through.
“People Also Ask” Google Queries
1. Should you hold calendar spreads through earnings?
The only time you would want to hold onto the spread past the earnings announcement would be if you anticipate the stock to stay near the strike price past the earnings report. In addition to this condition, you’ll also want to be sure that after an IV crush, the long leg of the spread is going to continue gaining value.
2. Can a calendar spread benefit from IV crush?
In a calendar spread, the short leg can benefit greatly from the effects of IV crush, which allows the entire trade to succeed. However, the timing must be correct, so the traders can reap this reward.
Pros and Cons of Calendar Spreads During Earnings
Using calendar spreads around earnings events can result in good outcomes for traders, but there are some cons to using this strategy, and traders should be aware of these risks and downsides to the strategy before proceeding. Check out the main pros and cons of using calendar spreads and discover if they could work well for you in your next earnings play.
Pros
- Takes Advantage of IV Skew: Calendar spreads profit from the difference in implied volatility and time decay between options that have the same strike prices but different expiries. It’s a good move for traders who are expecting the underlying asset price to remain stable or rangebound in the short term, but are expecting a rise in volatility later on.
- Lower Capital Outlay: Compared to outright long options strategies, the calendar spread requires much less capital to enter, which means that the net premium paid to enter the spread is reasonable.
- Defined Risk: The maximum loss associated with the calendar spread is limited to the net premium the trader pays to enter the spread. Knowing the max loss up front and knowing that it isn’t unlimited can help traders to prepare how much they’re going to allocate to the trade as far as the position size goes.
- Can Be Used in Neutral Environments: Traders don’t have to have an accurate outlook on the market going in a bearish or bullish direction, but they can still use a calendar spread if they have a neutral outlook on the markets.
- Flexibility with Volatility: Calendar spreads can turn a profit if the IV is rising or falling, offering a degree of flexibility in using the strategy. It mainly hinges on a difference in IV between the two options. On top of IV offering flexibility, there is the added layer of time decay benefiting the short leg of the spread.
Cons
- Limited Reward: If the stock moves sharply, the trader might not be able to collect as much in profit as they could have if the stock price moved more steadily.
- Requires Precise Timing: A big downside of the calendar spread is that it requires exact timing to be successful. There are a few moving parts with the expiration date timing and the movements of the underlying asset, which can make it tricky to navigate the trade successfully.
- Volatility Sensitivity: Calendar spreads can be negatively impacted by changes in implied volatility. A dangerous combination for traders is when the IV of the long and short options moves in the opposite direction from one another.
- Not Suited for High Gamma Environments: Calendar spreads don’t do well when the underlying asset is expected to experience big price swings. These spreads are already sensitive to price movements, and higher gamma can lead to reduced effectiveness and an increased risk of lost capital.
- Require a Lot of Active Management: Calendar spreads need to be closely watched after being set up. Traders might need to make adjustments to the position as they monitor its progress to deal with changes in the market. The higher level of active management required with the calendar spread makes it a more complex choice for traders.
Common Mistakes to Avoid
You can avoid some of the most commonplace mistakes and blunders that other options traders have made in the past and trade around earnings successfully using a calendar spread setup, so long as you become familiar with some of the ideas in this section! The more you can learn about what not to do, the better the outcomes you’ll likely have going into using this strategy for the first time.
- Holding Past Earnings Blindly: Unless you have a plan ahead of time, it is a bad idea to hold a calendar spread beyond the earnings report. The only reason to ever do this is because you anticipate the stock to stay near the strike price and the long leg of the spread to continue gaining value.
- Misjudging IV Expectations: The reason that we recommend traders use good broker apps and third-party apps or websites that let you check volatility levels, backtest strategies, or gauge market direction is that these tools can help traders to correctly judge IV expectations and find out which moves are the most beneficial for the situation at hand. If you get IV levels incorrect with a calendar spread, it can lead to some significant losses that you’ll regret.
- Wrong Strike Choice: You could make the mistake of using an OTM strike price, which greatly reduces the probability of profit for the spread. The poorly chosen strike can make it difficult to adjust the spread in any way if the market moves against your position.
- Wrong Timeframe Choice: Another big blunder can be choosing an expiration date that takes place too far in advance before earnings or entering the spread the same day as the earnings report release.
Advanced Tips & Variations
If you’re interested in taking your earnings trading strategy to the next level, consider using these variations on the calendar spread or taking a few of our advanced tips and implementing them into your current trading plan.
- Double Calendars for Earnings Straddles—This advanced move can profit from volatility crush, especially when the difference between the profits that are gained on the short leg of the spread and the losses incurred on the long leg of the spread will be positive.
- Diagonal Spread Variation—Combine your calendar spread with elements of a vertical spread to create a diagonal spread, which benefits from direction bias, but also profits from changes in volatility and time decay. The main difference here is that the spread has different strike prices along with different expiration dates, while still focused on the same underlying asset.
- Using Earnings Volatility Rank (EVR)—Using this metric can give you a decent idea of how unstable a company might be in comparison to others. Traders can learn about the percentage change in earnings between consecutive quarters or even years to learn the likelihood of the next report being good or bad news for IV.
Final Thoughts on Calendar Spreads
Calendar spreads are a great choice for trading around heightened IV levels going into earnings seasons or quarterly report releases by major companies. The appeal of these spreads comes from their flexibility in being able to perform in bear, bull, or neutral markets and from their benefitting from IV skew and time decay. Calendar spreads are a strong tool for earnings season that any investor should be using to profit from IV.
Though they’re a fine option for times when earnings reports are being made available to the public, calendar spreads aren’t a foolproof method for securing profit, and they aren’t low-maintenance strategies either—there is considerable preparation, timing, and discipline that comes with their use. It’s a strategy that we would highly recommend you paper trade with before going live.
Have you tried calendar spreads for earnings? Share your results below.
