You can calculate the implied move of an option by adding or subtracting the premium from the strike price. For instance, a $100 stock with at-the-money ($100 strike) call options that cost $10.00 has an implied move of 10%, with a breakeven price of $110. If this were a $10.00 put option, the breakeven would be $90.00.
Note: calculating the implied move of an option is different from calculating the implied move of a stock. To calculate the implied move of a stock, simply add the premium of the call and put together ($20 in the case of the example above).
If the implied move of an option ahead of earnings is 10%, and the stock only moves in your favor by 1%, your option may end up trading lower the next day even though you were directionally right. The closer to expiration your option is, the higher the risk of IV crush.
Understanding IV crush and theta decay are crucial to trading options on earnings.
Now that you understand the potential pitfalls of holding an option through earnings, let’s talk about Goldman’s previous Intel trade: a similar bearish trade in Intel ahead of their April 28th earnings.
Goldman issued the note with Intel trading at $47.01, with the trade idea being a slightly-out-of-the-money $45 strike put expiring at the following monthly expiration in May. The implied move of that option was 7%, meaning that the breakeven on this trade was roughly <$43.71 by the May expiration date. When earnings came around (April 28th), the stock closed roughly 7% lower (Intel closed at $43.59 that day) — satisfying the option’s expected move with more than 2 weeks remaining until expiration.
Long story short: Goldman was right, and the trade was profitable. The stock moved enough in their direction to outrun the theta decay and IV crush associated.
However, a long put isn’t the only way that Goldman could have used options to make a bearish prediction in Intel.
How to Use Vertical Spreads to Trade Earnings In the case of Goldman’s previous trade in Intel, if they wanted to take a bearish view using the $45 strike options, they could have chosen to use a vertical spread. Vertical spreads involve buying an option while simultaneously selling another option against it using the same expiration.
For example, Goldman could have bought the $45 strike put options and sold the $40 strike put options against them. This would have altered a few key things about the structure of the trade:
Short options are theta-positive. That means that when time passes, short options become more profitable. While the person you sold them to is losing money with the passing of time, you are on the opposite end of that trade, hoping that the option expires worthless.
By selling an option against your long option, you are lowering the total amount of premium you must outlay to enter the trade. If the long put option would have cost $1.30, and the short put option costs $0.80, now you have a strategy that costs $0.50! Alongside the change in cost basis comes another welcome change…
This is straightforward: If your $45 strike put option originally cost $1.30, the breakeven would have been <$43.70. If your position is now a $45/$40 put debit spread that costs $0.50, your breakeven is now <$44.50! This means the stock needs to move less in order for the position to become profitable. But everything has a catch, and in this case, the catch is…
A long $45.00 strike put technically has a max value of $4,500 — a dollar for every penny that the stock drops below $45, potentially all the way down to $0. However, by selling an option against your long put, you are now capping the maximum value of your position at the short strike. In this case, if you were using a $45/$40 put spread, the maximum value of your spread is $500 apiece at expiration— a dollar for every penny that the stock drops below $45, until it reaches $40.
In short: vertical spreads allow traders to mitigate some of the risk associated with holding options through earnings, in exchange for missing out on some of the potential reward.
The Bottom Line Hindsight is 20/20. We know that last quarter, Goldman may have been better off using a vertical put spread rather than a long put for their bearish Intel prediction. However, this quarter could prove different. The breakeven for near-the-money puts is just above a multi-year low in Intel’s share price. If Intel falls below that point on earnings, it may need to enter a period of price discovery in order to find a new bottom — which could be a part of why Goldman Sachs is so bearish on this name.
Just remember: holding long options through earnings and other known catalysts can come with a heavy amount of risk.. If you’re new to trading options, or you don’t have a strong opinion on Intel’s post-earnings price action, this “deep-end of the pool” trade may not be for you. However, you’re the master of your own domain. So, you be the judge.