Alternative Earnings Strategy: Sympathy Plays

4 min readJul 30, 2024

Earnings season presents excellent opportunities for options traders, whether you enjoy the thrill of picking a direction or prefer more sophisticated volatility strategies.

You can profit from implied volatility (IV) crush by selling options or go long on volatility by betting on a larger-than-expected move in the stock’s price.

Today, let’s discuss an alternative strategy that allows you to capitalize on earnings behaviour without directly trading stocks with upcoming earnings announcements.

What is a sympathy play?

When a publicly traded company announces major news affecting its share price, it often triggers significant stock price movements among its industry competitors.

These sympathetic reactions create opportunities for traders to capitalise on stock earnings across multiple companies.

What drives this reaction

Sympathy plays can occur between companies in different sectors that share a business relationship.

For instance, if Company A supplies products to Company B, robust sales reported by Company B often suggest that Company A might also experience higher-than-expected sales.

Sometimes, the rationale behind a sympathy play is not immediately clear. A stock might perform exceptionally well without any significant news.

Observing this, investors might flock to similar stocks, speculating that insiders or institutional investors have insights about the sector that they don’t.

Advantages of sympathy plays

Sympathy plays involve stocks that aren’t reporting earnings on the same day.

This strategic choice helps avoid the implied volatility crush, a common phenomenon where options prices drop sharply following an earnings announcement, leading to significant potential losses for traders.

With sympathy plays, we are not exposed to this risk and instead deal primarily with theta decay, the gradual loss of an option’s value as it approaches its expiration date.

At the same time, we are well-positioned to benefit from a significant stock move, making these trades low-risk with high potential rewards.

How to play

There are many ways to execute these sympathy plays.

For example, you can enter long volatility positions, such as straddles or strangles, on related stocks before the target earnings announcement.

The breakeven of these positions on the proxy stock will not be as high as for earnings, since there is no implied volatility (IV) crush.

This means the potential risk is only the theta decay of the overnight hold, while still being favorably positioned to profit from a mirrored big move if the earnings move happens, making for low-risk, high-reward plays.

Additionally, you can capitalise on momentum movements on the day of earnings.

If you observe a substantial move at the market open for the stock with earnings, consider entering calls or puts on the related stock to ride the momentum on the proxy stock.

Basically, whatever position you’d like to take on the original stock earnings can be taken on proxy stocks with less exposure.

How to find

To analyse the reactions among earnings results, we need to do some data crunching.

Essentially, we go stock by stock and calculate the movements of all other stocks on that stock’s earnings days.

For each pair of stocks, we compute a correlation score to determine how correlated the two stocks are, specifically on the earnings days of the first stock.

This process allows us to identify the stocks most correlated with each stock’s earnings. These highly correlated stocks can present good opportunities for sympathy plays.

Example

For example, we see that United Airlines’ earnings moves have a high correlation with Delta Airlines.

The correlation score is around 78%, indicating that when United Airlines experiences a significant move, Delta Airlines often moves in the same direction.

For instance, when United Airlines had a 10.1% move, Delta followed with a 5.4% move in the same direction. However, this isn’t always the case, as there are exceptions such as in October 2022. Overall, the statistical correlation is significant.

Be careful, though, because it doesn’t work both ways: the UAL — DAL correlation reflects how DAL’s earnings mirror UAL’s. Conversely, the DAL — UAL correlation is based on DAL’s earnings, which might not yield the same results.

The same shows for Southwest Airlines (LUV) with a similar correlation pattern with United Airlines.