Earnings season presents excellent opportunities for options traders, whether you enjoy the thrill of picking a direction or prefer more sophisticated volatility strategies.
You can profit from implied volatility (IV) crush by selling options or go long on volatility by betting on a larger-than-expected move in the stock’s price.
Today, let’s discuss an alternative strategy that allows you to capitalize on earnings behaviour without directly trading stocks with upcoming earnings announcements.
When a publicly traded company announces major news affecting its share price, it often triggers significant stock price movements among its industry competitors.
These sympathetic reactions create opportunities for traders to capitalise on stock earnings across multiple companies.
Sympathy plays can occur between companies in different sectors that share a business relationship.
For instance, if Company A supplies products to Company B, robust sales reported by Company B often suggest that Company A might also experience higher-than-expected sales.
Sometimes, the rationale behind a sympathy play is not immediately clear. A stock might perform exceptionally well without any significant news.
Observing this, investors might flock to similar stocks, speculating that insiders or institutional investors have insights about the sector that they don’t.
Sympathy plays involve stocks that aren’t reporting earnings on the same day.
This strategic choice helps avoid the implied volatility crush, a common phenomenon where options prices drop sharply following an earnings announcement, leading to significant potential losses for traders.
With sympathy plays, we are not exposed to this risk and instead deal primarily with theta decay, the gradual loss of an option’s value as it approaches its expiration date.
At the same time, we are well-positioned to benefit from a significant stock move, making these trades low-risk with high potential rewards.
There are many ways to execute these sympathy plays.
For example, you can enter long volatility positions, such as straddles or strangles, on related stocks before the target earnings announcement.
The breakeven of these positions on the proxy stock will not be as high as for earnings, since there is no implied volatility (IV) crush.