in this video I'm gonna be teaching you a powerful trading technique which is easy to understand and can double or triple the return potential of an overnight option strategy that you can use around the earnings release of a stock I'm Seth forever you're the head trader of SMB capitals options trading desk here in New York City and I'm approached all the time by traders on our trading desk about how to structure options trades around an idea that a trader has so I stick around if you're interested in learning a simple option strategy that you can
make right before the earnings release of stocks you follow and how you can double or triple the return potential of that trade [Music] I'd like to suggest that you click on our subscribe button right now so that you don't miss any of our free training videos that we produce for traders and investors all over the world they're really very valuable this past week one of the traders on SMBs desk here in Manhattan approached me about an options trade that he was planning to place in the last hour of the market right before Apple was scheduled
to release its third quarter earnings release so he asked me to take a look at the trade and provide my input on it well Apple was going to release its earnings that afternoon after the market closed and the trader who had some experience trading options understood the principle that options as they're approaching earnings for any stock have a very strong tendency to increase in price because stocks tend to make very large moves in either a positive or negative direction immediately after earnings releases as the world gets a fresh idea of how that company has been
performing lately and what its prospects for the future are I want to make sure that you understand this principle thoroughly because to understand what happened on this trade you really need to understand what happens with options on stocks right before and right after earnings are released you see the reason that options traders and market makers tend to bid up the price that trade traders pay for options as they approach earnings is that the seller of that option whether he's a market maker or an independent trader by selling you that option is taking the risk that
the option he's selling you will be triggered in which case he'll lose money unless he has built enough profit into that option that even if it gets triggered he can still make a profit from having sold you that option and that risk gets way bigger as earnings approach so for instance let's say that XYZ stock is trading at $250 a share one month before earnings so let's say hypothetically someone wanted to buy a call expiring one day later which permits the call buyer to buy 100 shares of XYZ stock at 250 no matter how high
the stock is trading the next day so let's say the seller of that option prices that at one dollar for each of the 100 shares for this so the seller would receive $100 for selling that right to the call box so here's the break-even analysis on that trade if XYZ runs up to 251 the call seller will break even because he'll have to go out and buy shares at 251 to deliver those same shares at 250 so he's gonna take a $1 loss however he collected $1 for the call option so actually he breaks even
at any price higher than 251 he would lose money because the call premium he received would not cover the loss he was taking on the shares he had to deliver to the owner of the call so just logically around earnings think about it the cost of that at the money call would have to go up a lot wouldn't it because if a month earlier the market price for that at the money call was $1 that means the market figures it's not a bad bet to think that the stock will go up by less than $1
over the next day but earnings isn't just any old day it's a day where if the market loves the earnings report the stock could go up many multiples of $1 let's say on average you could move as much as $10 on a favorable earnings report then would it be smart for the market maker to price that option at $1 as though the next day was any old day of course not his price would be a lot closer to $10 than it would be to $1 because the risk of that earnings move to the call seller
is way higher of his having to go out and buy shares at say 260 and then deliver them at 250 taking a $10 loss per share right around the earnings that increase in options prices they approach earnings is known as an earnings related increase in what options traders call implied volatility and it's a very important principle in options trading all right so knowing that the desk trader in this case asked me what I thought of this trade so it was about 3:15 on the afternoon that the earnings were going to be announced for Apple so
you can see that Apple was trading at 243 so the closest strikes available where the 242 5 calls and the 242 5 puts so what the trader wanted to do was to short those at the money options now those at the money options are just about as pumped up as they can be price-wise because earnings are coming out within an hour so they're real we blurred in meaning that the price of the option that he's selling is way higher than usual which is great because he's not buying them he's selling them then for protection he
was proposing that he'd go out and buy a call 20 points higher than that at two sixty two point five and a protective put twenty points below the short put at two twenty two point five now this structure is called an Iron Butterfly and it's a popular strategy to deploy right before earnings are released so the trader asked me what I thought of the trade and my reaction was I liked the idea but I think that there's a much better way to do this that will cut your risk way down on the trade while giving
you the opportunity to make a way better gain on the trade from a return standpoint then he was suggesting originally now before I share with you the idea that gave the trade so much more potential I wanted to mention to you that we're currently running a two our free intensive workshop at the moment where we'll be teaching you three real-world option strategies that professional options traders use including a really simple but incredibly effective strategy there's some of the greatest investors in the world like Warren Buffett use all the time plus an options trading strategy that
has a statistical 80 percent probability of profit month in and month out plus an option strategy that you can employ with a stock that you like where you'll make your target profit whether the stock goes up goes nowhere or even goes down a small percentage so if those strategies would be of interest to you then you should check out the free options class that we're currently running just go ahead and click the link that should be appearing right now at the top right corner of your screen that will open a free registration page in a
new window so don't worry you won't lose this video or you can just head on over to options class com to register for this free intensive workshop it's a rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so click the link to sign up now and don't miss it okay so getting back to the trade what I suggested to him is that by moving the protective put and call much closer to the short options while he'll pay more for
those options because they're closer to the market price of the stock that the capital that he'll be using will be so much less and therefore the result of the trade is likely to be a much higher return on capital than the original trade that he was proposing you see for trade like an Iron Butterfly a broker will require you to put up a certain amount of capital because of the amount of risk in the trade we can get into that another time exactly how that's calculated but for the purposes of today's lesson I'll just tell
you that a broker would margin him ninety two hundred dollars for the trade that he was suggesting so what I suggested to him in return was that he pull his long options in much closer to the money instead of being 20 points away from the short options I suggested that he pulled them within 12 and a half points away from the short strikes so that the long calls were now at 255 and 240 as you can see from this options chain now the difference in capital utilization is huge because the new trade where the long
options are only 12 and a half points away from the short options only uses up $3,650 of capital as opposed to the $9,200 on the trade that he was proposing okay so now let's move forward to the next morning after apples earnings were announced to see what actually happened on this trade it's interesting for a bunch of different reasons so the next morning at around 11:00 Apple rallied up to 245 the market basically liked the turnings reports of the next morning the options pricing for each of the options in the trade looked like this you
could see that every option dropped in value from the price that it had the previous afternoon before earnings came out so it may not be apparent just yet but the trader has actually made a huge profit on this trade in less than 24 hours now let's first drill down and understand why this was the case you see when he first initiated the trade he received six dollars and 20 cents for the short calls and five dollars and 60 cents for the short puts he also simultaneously paid a dollar 52 and a dollar 48 for the
long call and the long puts respectively so remember each operat option represents 100 shares so we need to multiply all these prices by 100 and also remember that he bought ten of each of these options so we have to multiply all the income and all the costs by ten so if you go through all the math and net everything down he received eighty nine hundred dollars into his account for initiating this trade now when we get to the next day and he wants to close the trade he needs to reverse the whole transaction so let's
take a look at how that would have played out now as you can see all the options have shrunken value that next day why because there was no more mystery around the earnings report than market liked it mildly and was rallying mildly the mystery is over so the options are much less risky for the sellers and therefore they dropped the price to normal levels there isn't a giant unknown out there anymore driving up the prices of the options and so let's break down what the trader did to close the trade well the to 55 calls
shrunked out the ten cents so selling them he got just back a hundred dollars for those even though he paid a dollar forty fifty two for them originally he had to pay in turn $4.95 to close the calls the short calls remember he received six dollars and 22 cents for those originally so that was a nice win he also had to pay 48 cents to close the short puts but he received five dollars and sixty eight cents for those originally so that was a really nice win finally he received three cents for the long puts
down at two forty four whopping thirty dollars an income so the total cost to close the trade was fifty-three hundred dollars and so as you can see because he received eighty nine hundred dollars to open the trade and it cost him only two fifty three hundred to close it the trader made 36 hundred dollars on the trade and all that all of that took place because the market reacted mildly to the earnings report the options all shrunken value as the unknown event passed and we were able to shut everything down for much cheaper than we
would have been able to before earnings and so we made really good money because of what options traders called the volatility that takes place immediately after earnings are released so on its own that was a really nice trade but I'd like you to focus on something else remember I told you that the capital required for the trade was thirty six twenty well the trade made thirty six hundred so that's a return of ninety nine percent and that's overnight it's not bad now remember that the final trade we decided on with was with long option to
twelve and a half points away from the short options well when you go back and look you'd see that had the trader and entered into his original trade where the long options worth twenty points away from the short options an interesting thing happens the trade made more actual money of course because the farther the long options are away from the market the cheaper they're going to be so the trader made actually five thousand three hundred fifty dollars on the trade that he suggested but he had to risk much more capital in that trade so his
return actually plummeted down to fifty eight percent from ninety nine percent looking at in another way had the trader decided to double the size of the actual trade that he made the one with the tighter wings to a capital size of 72 forty he would have made seventy two hundred dollars on much less capital than the wider wing to trade would have made see how powerful it was to pull in those wings so they're really two lessons to be gleaned from this video not only did we see the extremely powerful aspects of volatility crush before
and after earnings and how much money can be made quickly by playing earnings iron butterflies if the stock doesn't move dramatically as a result of the earnings release but more importantly I wanted you to understand how powerful it is to cut capital on your options trades thereby providing a massively increased potential for return compared to larger amounts of capital by spending less on your protection and buying wings much farther out the professional traders focus on risk control and that's a major way that they can make elite level returns on their trades now just to remind
you as I said earlier if you enjoyed this video and learn something valuable from it we'd like to learn the details of three real-world option strategies that professional Streeters use all the time then you should check out the free options class that we're currently running just go ahead click the link that should be appearing now at the top right corner of your screen that will open up the free registration page in a new window so you won't lose this video don't worry or you could just go ahead over to options class comm to register for
this free intensive workshop it's really a rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so now it's your turn now every trading platform out there offers a paper-money account to their customers so that you can get used to the trading platform and experiment with trade so purely as a pay per trade why don't you pick a stock which is coming up for earnings in the near future and place a paper earnings Iron Butterfly on that stock and in
the comment section tell me what strikes you pick to see if you're actually grasping this concept I'll reply with any thoughts I have on the trade and we can turn this into a learning experience I'm looking forward to your trade ideas so don't forget
