Developing a trading strategy
|At the time of writing this article, we’re deep into the middle of earnings season. Lately, I’ve been working on an earnings strategy and I wanted to share it with you today. This article focuses on a question that many traders ask:
How can I develop a profitable trading strategy?
To answer this question, we’re going to look at a strategy I’m currently developing, and how I’m doing it.
I’ve been working on this specific strategy because I know that earnings seasons provides a unique opportunity to make money.
The concept behind this strategy is selling options premium around earnings. This type of strategy is also known as a strangle.
Around earnings, the implied volatility increases, also increasing the options’ premium.
The goal is to sell premium for the inflated amount before the earnings announcement.
In a strangle, you are both selling a call option and a put option, ‘strangling’ price between it.
The idea is that after a company announces it’s earnings report, the IV in the options gets crushed…this is how we make money with this strategy.
This basically means that the premium in the options evaporates. Since premiums were higher when the options were sold, I can now buy them back at a reduced rate.
So to make money with this strategy, you need the price of the underlying asset to be trading between the strikes you sold at the time of expiration.
Testing this strategy On Wal-Mart (WMT)
In this trade example, I’m going to trade a strangle around Wal-Mart’s earnings. With this specific trade, I’m going to sell a call $10 above the strike price and a put $10 below the strike price.
Wal-Mart is currently trading at $128. I will sell the $138 call and the $117. I will have a profit target of 70% for this trade.
It’s important that you establish a profit target, with entry and exit points. This type of trade should be monitored closely.
I’ve traded this strategy 8 times now, and every time it has worked like a charm! This strategy works well with stable stocks that don’t move a bunch around earnings.
Most people have this idea that all stocks are super volatile around earnings when in reality, the vast majority barely move at all. This is exactly what we’re looking to take advantage of.
As part of my testing method, I like to trade a strategy around 40 times to determine whether it is profitable over a longer period of time.
Using tools to test your strategy
I’ve spent some time developing a tool that I like to call the “Earnings Strangle Calculator.”
I use this tool in several different ways. When I develop any trading strategy, I always include how much I’m willing to lose/risk on every single trade.
This tool calculates the size of the position you can take based on your account value and the price of the option. You can also use this tool to compare option trades.
Tools play an important role in all of my trading strategies. Not only do they save me time, they help to keep my consistent and disciplined.
How YOU can develop a profitable trading strategy!
When developing your own trading strategy, it’s important to use the same criteria for each trade. Don’t start things off one way, then change if things aren’t working midway through.
This ensures you’re testing will result in accurate data. Also, testing your strategy multiple times is very important. As I mentioned, I often test a strategy around 40 times to ensure that I have enough data to be statistically relevant and determine whether the strategy is actually profitable.
This number can vary depending on the market conditions and the type of strategy.
When developing a strategy it’s important to not only find one that’s profitable, but also matches your lifestyle and risk tolerance.
Recap
- Find a trading idea that you think will work for your style.
- Set up rules or criteria to test your trade.
- Find tools to help you with the process.
- Test your strategy many times over a period of time.
Using this information, anyone can develop a profitable trading strategy over time. Developing a new trading strategy takes patience and time.
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