The earnings calendar is one of the most volatile periods in the market—but that volatility can be turned into an opportunity.
Our guide explores how to strategically use Iron Flys and Diagonal Spreads to capture profits from implied volatility swings around earnings events. As you read, you will learn everything you need to know about these two strategies, including the setup mechanics, risk profiles, trade timing, and when to avoid each strategy. Each has its own place when trading around earnings season, and the IV that comes during that time—get familiar with the iron butterfly and the diagonal spread to trade around earnings like a pro!
Why Earnings Season Matters in Options Trading
Earnings events cause spikes in implied volatility because they are known ahead of time by the markets, but it’s a complete guessing game as to which direction they’ll be going or how powerful the impact will be on the stock price. As a result, implied volatility for stocks whose companies are releasing earnings reports will increase, reflecting uncertainty about where the price might go once the report is made publicly available.
IV Increases before Earnings
Why does this earnings season matter to the average options trader?
There’s an opportunity in these scenarios to utilize the IV build-up before the earnings report to trade and sell overpriced premiums. Increased IV causes the price to enter the position to go up, increasing the value of the premium, and traders can receive money from a buyer in exchange for the obligation to buy or sell the stock at the strike price and by the expiration date. It’s a strategy that focuses on income generation, and it can be used to great effect around earnings.
IV Crush Explained
However, there is a phenomenon that occurs once the earnings report has been made public, and it’s called “IV crush.” It’s where the increased level of IVB completely collapses post-announcement, and it can devalue options contracts greatly, even those that were correct in terms of getting the stock price direction right.
Planning the Right Strategy
To inform how you’re going to trade around earnings announcements and the ensuing IV that comes with them, you’ll need to know that any stocks that are attached to companies getting ready to release earnings data are subject to go up by 30-60%. However, immediately after the earnings announcement has passed, IV is expected to decrease by 25-40%.
With these dangers in mind, let’s take a look at a few options trading strategies that traders can use to trade around earnings but not get completely burned once the event has passed. Keep reading to learn about the Iron Fly for neutral or range-bound expectations or the Diagonal Spread for direction plays and IV edge!
Strategy 1—Iron Fly for Neutral or Range-Bound Expectations
The first strategy that we would like to address is the iron fly or the iron butterfly, which is a market-neutral approach that consists of four legs. The iron fly turns a profit when the stock stays close to the strike price. To anyone reading this who has a concept of other strategy types, the iron fly is fairly similar to a short straddle, but it has the major difference of having protection on both sides.
What Is an Iron Fly?
As we already pointed out, the iron fly strategy is made up of four legs or four separate trades that are all executed at the same time. The trader will buy an out-of-the-money (OTM) put, sell an at-the-money (ATM) put, sell an at-the-money (ATM) call, and buy an out-of-the-money (OTM) call.
Best Case Use
The following are the ideal conditions for using the iron fly. There are several instances where this strategy can secure traders a profit, and they usually revolve around steady markets.
- Low Volatility is Expected: Because the iron butterfly profits from the underlying asset trading within a narrower price range and profits from time decay, it’s best to use when the expectation around earnings is minimal price movement.
- Defined Risk/Reward Profile: Iron butterflies come with a profit and loss limit known upfront, so they are a good choice for traders who prioritize risk management of a higher degree and want to plan their trades around these principles.
- Traders Are Feeling Neutral on the Underlying: When stocks are expected to stay rangebound or the price of the underlying is expected to move very little in either direction, it can be a great time to use an iron butterfly. The more neutral the market outlook on the underlying, the better.
- Right After Earnings Announcement: When the market has factored in the impact of implied volatility on the stock’s price and volatility is expected to decrease greatly following the report’s release, the iron butterfly can be used to great effect!
Trade Setup for Earnings
How can you use an iron butterfly to the best possible effect around earnings season? We have outlined a great example using Netflix stock to give you a good illustration of how the strategy is structured and how it will make money.
Example with Real Stock
Netflix (NFLX) stock is currently trading at $180. This is how you would organize the four legs of the iron fly you’re setting up:
- Sell an at-the-money put ($180)
- Buy an out-of-the-money put ($175)
- Sell an at-the-money call ($180)
- Buy an out-of-the-money call ($185)
Choosing the right expiration involves planning it for the day right after the release of the earnings report. When it comes to timing the entry of this trade, you should get in a day or two before the report is made public to make the most of the IV surge during that time. Going about it this way helps traders to enjoy the maximum premium that is possible, and then terminating the trade right after the report to avoid IV crush.
Pros & Cons
✅ High premium potential
✅ Defined risk
❌ Risk of directional breakouts
❌ Needs tight movement
Strategy 2—Diagonal Spread for Directional + IV Edge
The next strategy that we’d like to focus on that does well when trading around earnings season is the diagonal spread, which is a combination of a vertical and calendar spread—traders are buying and selling options on the same underlying and also using different strike prices and different expiration dates.
What Is a Diagonal Spread?
Keep reading to discover the ingredients that are needed for forming a successful diagonal spread that can benefit when there is a moderate price movement in the underlying asset and its value.
- Structure: The first step is for the trader to buy long-dated options and then sell short-term options of the same type (call or put). The strikes and expiration dates are going to be different, however.
- When to Use: The best case scenario for using an iron fly is when you expect a moderate price movement in the underlying asset, coupled with a bullish or bearish bias. The diagonal spread also works well when traders are anticipating IV crush following the earnings announcement.
Trade Setup for Earnings
To give you a general idea of how the diagonal spread is designed and how it could play out, let’s look at an example involving the Apple stock (AAPL), which is currently trading at $400. Setting up a diagonal spread for a direction play and to gain an IV edge would be done in two easy steps:
- Step #1: Buy a call option for $410 whose expiration date is 30 days away
- Step #2: Sell a call for $405 whose expiration date is within the week
When traders begin putting together the directional spread for the Apple stock, it is key for them to choose their strike prices based on sentiment or guidance expectations. Plus, they must also use different expiration cycles to capture IV decay on the short leg.
Pros & Cons
✅ Benefit from directional move + IV drop
✅ More forgiving than a calendar
❌ Requires accurate bias
❌ Can underperform if the move is too small or too late
Choosing the Right Strategy—Iron Fly vs. Diagonal
If you’re new to using either of these strategies and you’re uncertain which one you should be using based on your situation, skill level, or trading goals, we have put together a small chart here that you can use as a guide for making these decisions. The side-by-side comparison chart includes a lot of relevant information, including risk/reward, IV impact, directional bias, and timing.
Iron Flys and Diagonal Spreads Compared
Comparison Point | Iron Fly | Diagonal Spread |
|---|---|---|
Risks | Defined with tight range | Defined with tighter range |
IV Impact | High IV and expecting crush | High IV and expecting crush |
Directional Bias | Neutral | Directional |
Timing | 1-2 days before earnings | 1-3 days before earnings |
When It Profits | Near the strike | Near the sold strike |
Decision Flow
- Neutral on earnings? → Use Iron Fly
- Mild directional bias with IV edge? → Use Diagonal
Risk Management & Position Sizing
While trading around earnings can be exciting, traders need to be careful in executing these moves and take the proper precautions when it comes to risk management and using correct position sizing. Going “all in” on earnings plays is making a big gamble because trading around earnings can be unpredictable, and traders can lose a lot of money if they aren’t careful. This is why traders should use the following best practices for using these strategies:
- Suggested Sizing: Traders should be using no more than 1-2% of their portfolio per play, which is common sense from a risk management perspective. Keeping the position size low can minimize losses over time if these earnings plays consistently don’t work in your favor.
- Avoiding Earnings “Lottery Tickets”: Earning plays aren’t about taking your chances in the hopes of the trade working out. It’s all about finding a consistent edge that is in line with what is likely to happen upon the release of the earnings report in terms of market direction and price movements.
Tools & Resources
For anyone who is interested in decoding earnings volatility and accessing the tools needed to get the job done effectively, they might want to check out the following broker apps or online tools that we have outlined in this section of the review.
Suggested Platforms
- OptionsStrat: This app contains useful tools such as a strategy visualizer, calculator, options flow, and access to IV and skew metrics. OptionStrat is a great choice for traders who would like to assemble multi-leg trades around earnings events.
- OptionNet Explorer: Traders using this app can access implied volatility analysis and volatility adjustment, along with several other useful tools. The backtesting capabilities are a significant point of interest where traders can begin to understand the historical performance of volatility strategies like iron condors, straddles, or strangles.
- ThinkorSwim: This one offers a wide suite of tools for trading around earnings season, like scanners and filters for high IV levels. On top of that, there are also VIX tools and IV charts or indicators that can give traders an idea of how the next earnings report will shake out and its effect on the stock prices.
Earnings Calendars With IV Data
- Earnings Whispers: A provider of real, professional whisper numbers for traders or investors who operate on a more professional level. They are notable for delivering some of the more reliable earnings expectations for their customers by comparison to other platforms.
- Nasdaq: Traders can access earnings calendars and other lists that have the expected dates when companies listed on Nasdaq will announce their quarterly financial results.
Final Thoughts on Iron Flys and Diagonal Spreads
When earnings reports are to be released soon, these can be big opportunities for traders, so long as they approach the situation with strategy in mind and discipline to carry out their trading plan. Use the Iron Fly when you have a neutral view on the direction of the market or a Diagonal Spread when you are looking for IV edges with a slight bias in either direction.
Anyone who is unfamiliar with trading around earnings or using strategies like Iron Butterflies or Diagonal Spreads should use paper trading simulators to get some practice in before using real money in a live market. It’s also a good idea to keep position size smaller than usual in the beginning to eventually build skill before scaling things up to the next level.
