Selling put options before a company’s earnings announcement can be a valid strategy for options traders looking to capitalize on volatility.
One of the main reasons traders may consider selling an Advanced Micro Devices (AMD) call option ahead of the company’s earnings announcement is the elevated implied volatility. Earnings reports can trigger significant price movements, and this volatility results in an increase in option premiums. By selling the put option before the announcement, traders aim to capitalize on the inflated premium, especially if they believe the stock will remain above the strike price until the option’s expiration date.
Before delving into the strategy, let’s quickly recap what it means to sell a put option. A cash-backed put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to either have the put expire worthless and keep the premium or be assigned and get the stock below the current price.
Selling put options is an easy place for investors to get started with options. They are like a covered call and are pretty easy to understand once you know the basics.
Traders selling puts should understand that they may be allocated 100 shares at the strike price.
Potential Benefits
Selling put options allows traders to collect premium income up front. If the options expire worthless, the seller keeps the entire premium as profit.
The premium received can lower the point of profitability for the business. If the stock price falls but remains above the breakeven point, the seller still profits.
Traders who are bullish or neutral on AMD can benefit from the increased volatility leading up to the earnings report.
After the earnings announcement, implied volatility tends to decrease significantly, reducing option premiums. By selling options before the announcement, traders can take advantage of this implied volatility drop.
Potential Risks
If the stock price falls below the strike price of the call option, the seller may be forced to buy AMD stock at a higher price than the current market value.
While the profit potential is limited to the premium received, losses can theoretically be unlimited if the stock price declines significantly.
Earnings surprises could result in a sharp drop in AMD stock price.
Selling an AMD Put Option
A trader selling the February 2nd, $170 strike on AMD would get about $440 into their account, which they would have to keep.
If AMD falls below $170 by Friday afternoon, they would be required to buy 100 shares at $170. The effective net cost of the position would be $165.60, thanks to the option premium received.
That is 6.88% below yesterday’s closing price.
If the stock remains above $170 at expiration, the put expires worthless, leaving the trader with a 2.66% return on capital at risk.
That works out to be 138.54% annualized.
Conclusion
Selling an AMD put option before their earnings announcement is a strategy that can potentially generate income by taking advantage of increased volatility. However, it is essential to understand the risks involved, including the possibility of assignment and unlimited losses.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for educational purposes only and not a business recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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At the date of publication, Gavin McMaster did not hold (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is for informational purposes only. For more information, please see Barchart’s Disclosure Policy here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.