Selling put options before a company's earnings announcement can be a valid strategy for options traders seeking to capitalize on higher than normal volatility. 

One of the primary reasons traders may consider selling a Wells Fargo (WFC) put option before their earnings announcement in early July is the elevated implied volatility. Earnings reports can trigger significant price movements, and this volatility results in an increase in option premiums. By selling the put option before the announcement, traders aim to capitalize on the inflated premium, especially if they believe that the stock will remain above the strike price by the option's expiration date.

Before delving into the strategy, let's quickly recap what it means to sell a put option. A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to either have the put expire worthless and keep the premium or be assigned and acquire the stock below the current price.

Selling put options is an easy place for investors to start with options. They are like a covered call and are pretty easy to understand once you know the basics.

Traders selling puts should understand that they may be assigned 100 shares at the strike price.

Potential Benefits

Selling put options allows traders to collect premium income upfront. If the options expire worthless, the seller keeps the entire premium as profit.

The premium received can lower the breakeven point for the trade. If the stock price drops but remains above the breakeven point, the seller still profits.

Traders who are bullish or neutral on WFC can benefit from the increased volatility leading up to the earnings report.

After the earnings announcement, implied volatility tends to drop significantly, reducing option premiums. By selling options before the announcement, traders can take advantage of this implied volatility drop.

Potential Risks

If the stock price falls below the put option's strike price, the seller may be obligated to buy WFC shares at a higher price than the current market value.

While the profit potential is limited to the premium received, losses can theoretically be unlimited if the stock price drops significantly.

An earnings surprises could result in a sharp drop in the price of WFC stock.

Selling a WFC Put Option Before Earnings

A trader selling the July 18, $70-strike put on WFC would receive around $131 into their account, which would be theirs to keep. 

If WFC falls below $70 by July 18, they would be required to buy 100 shares at $70. The effective net cost of the position would be $68.69, thanks to the option premium received.

That is 6.10% below yesterday’s closing price.

If the stock stays above $70 at expiry, the put expires worthless, leaving the trader with a 1.9% return on capital at risk.

That works out to be 21.8% annualized.

This table shows other potential put selling candidates on Wells Fargo for the July 18 expiration.

On the Wells Fargo volatility charts, we can see the term structure shows that implied volatility is very high for the expiration immediately after earnings.

This 30% volatility means high option premiums when compared to shorter-term options which only have volatility of around 24-25%.

Company Details

Wells Fargo & Company is one of the largest financial services companies in the U.S.

The company provides banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage services and consumer and commercial finance through more than 4,700 retail bank branches, broad automated telling machines (ATMs) network, the Internet and other distribution channels globally.

It has 4 segments. Consumer Banking and Lending offers products and services like checking and savings accounts, credit and debit cards, as well as home, auto, personal and small business lending to consumers and small businesses.

Commercial Banking provides banking and credit products across industries, and treasury management.

Corporate and Investment Banking delivers services related to capital markets, banking and financial products.

Wealth and Investment Management provides personalized wealth management, brokerage, financial planning, lending, private banking, trust and fiduciary products and services.

Conclusion

Selling a Wells Fargo put option before their earnings announcement is a strategy that can potentially generate income while taking advantage of heightened volatility. However, it's essential to understand the risks involved, including the possibility of assignment and unlimited losses. 

Conservative investors may consider buying a further out-of-the-money put to reduce the risk and capital requirements.

This essentially turns the trade into a bull put spread.

Please remember that options are risky, and investors can lose 100% of their investment. 

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.