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TL;DR: I created an alert system with AI that finds overpriced options right before earnings, and then I trade a short straddle setup betting on the IV crush. I'm averaging \~84.74 % annual returns.
Important: A lot of the ideas for this strategy came from a youtuber called volatility vibes. I highly recommend you guys to check out his channel. He writes the code for the filters manually which I automate here with Claude, also I have added some pre conditions of my own to adjust for my own risk appetite. Before getting into the post, I just want to preface: this is by no means financial advice, so take it at your own risk.
**The core idea**
The strategy is pretty simple tbh. (You can skip to the filtering section of the post if you know what an earnings IV crush is.)
Right before earnings, options can get EXPENSIVE. This is due to one reason: Uncertainty. Which usually means that:
1. Institutions will hedge their positions cuz of tight risk or drawdown rules
2. Retail traders are speculating (hoping) on big moves
And since options are basically insurance contracts, uncertainty in this case == expensive.
In other words this increase is captured in Implied Volatility / IV, which is essentially the market's expectation of future price movement baked into option premiums.
The opportunity arises when the IV overestimates the movement of the stock’s price on the earnings dates, i.e., the market is more fearful than it should be.
Lets say the market prices options before earnings as if a stock might move ±20% on the day of the report, but it only moves ±5%, the excess premium built into those options earlier disappears rapidly. In finance terms, this is called an IV crush.
https://preview.redd.it/0jtwwx505fzg1.png?width=700&format=png&auto=webp&s=7c2fd52313306b7cdcdbdde23ce0e1fff54cd98a
The strategy **capitalizes o**n this fear:
* Sell premiums when IV is elevated pre-earnings, then close the position once IV normalizes post-announcement.
I know what you’re thinking, there’s no f’ing way this works. And you'd be right. If you spammed this shit on every earnings report, yeah no shot you’d make any money.
The key to this strategy is **Pre-Filtering** for the right earnings events. **Because how do you actually know that the stock will underperform come earnings date?**
Now ofc there is **no** magic formula that predicts the future, but trading is all about taking calculated risk for potentially outsized returns. Here is my filtering criteria that do with AI :
1. **Historical earnings movement consistency.**
1. You wanna find stocks that have consistent intraday price action around earnings. To do this, take a list of 100-200 based on some super simple screening criteria (market >1b, no OTC, primary listing, US market only etc.). Then you wanna look up their historical earnings and check for intraday consistent price action movements of the stock around the earnings dates. This should give you an idea of the stocks that are way jumpy on earnings, you wanna exclude these in the next steps.
https://preview.redd.it/num1sy505fzg1.png?width=824&format=png&auto=webp&s=77f511889d670398a17cd2bf28fdf3837ad3c71c
1. **A negative term structure slope**
1. This sounds complicated but essentially:
1. We are looking for near-term options that are pricing in WAY more chaos than longer-term options. This happens when everyone's panicking about the immediate earnings, but the market doesn't expect long-term volatility. It's a sign the **fear is overpriced SHORT-TERM**
2. Term structure = comparing IV at different time periods
3. Formula: (IV 40-45 days out - IV nearest expiration) / IV Front × 100%
4. We want this to be below -15% (the more negative, the better).
2. **IV/RV Ratio > 1.25**
1. IV = Implied Volatility (what the market THINKS will happen)
2. RV = Realized Volatility (what ACTUALLY happened recently)
3. If IV/RV is above 1.25, it means options are pricing in 25%+ more movement than the stock has actually been moving.
**Trade Setup: Short Straddle**
1. Sell an ATM call AND an atm put with the same expiration date nearest after earnings.
1. The idea is you're collecting a max premium from both sides. When IV crashes post-earnings, both options lose value
https://preview.redd.it/teucw9605fzg1.png?width=785&format=png&auto=webp&s=25e2334e5cd3185f22c93a3a462940c8ad950795
**The risk**
This is obv, high risk high reward, if the stock absolutely rips or tanks way more than expected, you're screwed. That's why filtering is everything.
for those of you actually looking to run this strategy, I'd highly recommend turning it into an alert system. It needs to be run daily, so unless you've got a spare 1-2 hours every day to do it manually, an alert is the way to go.
**Alert Setup** (Skip this if your gonna do it manually
***Prompt:*** *“have this strategy constantly running in the background and alert my email every time there is a new candidate”*
https://preview.redd.it/xnroi4605fzg1.png?width=2048&format=png&auto=webp&s=28de91007a7e6e7b3f38d73c3b8a7363c68ab28a
**How to Actually Trade This**
1. Keep track of earnings seasons.
2. During earnings seasons, run the filters every single day and analyze potential candidates.
3. Position Sizing: Risk 6-10% of capital per trade max.
4. Timing:
1. Entry: 15 minutes before market close the day before earnings
2. Exit: Within 15 minutes after market open the next day
5. Discipline.
1. You take your profit/loss in the morning and GTFO. No "let me hold a bit longer" BS. The edge is in the IV crush overnight - that's it. There will be losses ofc but you need to cut early as well to
**Results of this strategy:**
I have been trading this strategy for the past 2 years. There are definitely periods of drawdowns, with correct risk management these can be mitigated if you fudge with the variables. Any ways here are the stats:
* Average return/trade \~ 10%
* CAGR \~ 84.74 % vs 25.62% SPY
* Max loss = 90%
* Win Rate = 65%
* Max Draw down \~ 25%
* Max drawdown period \~ 2 months ( def gonna need some discipline and iron hands to stick)
**Final disclaimers:**
**Needless to say this obviously is not financial advice.** AI can ofc make errors even if it has the data plugged in like this one. The calculations and code need to be precise for it to work so do some iterations and don’t use it as your oracle to the stock market.
I definitely think there are way more optimizations to be made here, I’m still trying them out as i go along. Will report back again on earnings season with my screening results and trade entries if yall are interested. Lmk know below.