Cleveland-Cliffs (CLF.US) earnings report approaches! Option traders prepare in advance to guard against sharp stock price fluctuations

Being fooled once, you can blame others; being fooled twice, you can only blame yourself. For Cleveland-Cliffs (CLF.US) investors, this seems to be the mantra they repeat as the steel giant prepares to release its earnings report.

According to Zhitong Finance APP, Cleveland-Cliffs’ earnings report to be released on October 19 will be a market focus. Option traders are on high alert. After the company released its quarterly results in July, the stock price surged nearly 16% in a single day—almost twice its long-term historical average daily volatility of just over 8%. Since then, traders, concerned that a similar move could recur, have aggressively bid up short-term options implied volatility (IV). Moreover, current short interest in the stock stands at nearly 14%, and the company’s CEO is famous for confronting bearish traders head-on. He once said that he likes to “slow-cook those shorts like frogs” and claimed “they messed with the wrong guy.”

With such remarks, it is no surprise option traders remain alert to the possibility of sharp price swings in Cleveland-Cliffs. For strategic option premium sellers, this elevated short-term panic has created a compelling opportunity to employ a “strangle-swap” strategy. Traders or strategists sometimes refer to this as a “double diagonal spread.” This structure allows traders to benefit from the expected drop in implied volatility after earnings are released (the so-called “vol crush”), while avoiding the unlimited risk that comes with naked short strangles.

To execute this strangle-swap strategy, the trader sells a short-dated strangle while buying a longer-dated strangle, thus defining the risk bounds. The key to this trade lies in the difference in the rate of implied volatility decay between the November short-term options being sold and the January longer-term options being bought.

Fearing a repeat of the sharp moves following the previous quarterly earnings report, traders are heavily buying November options. Whether or not such volatility materializes, when Cleveland-Cliffs reports earnings on the 19th, this binary uncertainty will dissipate, causing implied volatility in the November options to drop sharply—a phenomenon usually known as “vol crush.” However, since the January options still have significantly more time until expiration, they are less sensitive to this immediate implied volatility drop and also experience much slower time value decay (theta).

If, after the earnings release, Cleveland-Cliffs’ share price stays between $11 and $17, this strategy will yield its maximum profitability. In this scenario, the November short strangle will rapidly lose value. Traders can then buy back the short legs using only a small portion of the $0.80 premium received initially, or simply let them expire worthless. Thus, the trader can continue to hold the January 10/18 strangle almost for free, securing exposure to future price moves for the remainder of the year at little to no cost.

However, if Cleveland-Cliffs’ stock repeats or surpasses the explosive surge seen in July, this strategy will incur losses. Since the sold $11/$17 strike range is narrower than the bought $10/$18 range, should the price make a sharp one-sided move, the intrinsic value of the short options will increase faster than what the long options can offset in the short term.