Howdy ladies and gents.
It is I, Merlin of the Society of Market Sorcery, here to give you insight once again into the wild and wonderful world of Options trading.
Now that we have discussed the basics of how options work, and how you can use them to both manage your risk to a reasonable level, while simultaneously setting you up to collect gigantic gains should your directional predictions come to fruition, let’s move on to a more advanced type of option trade.
The earnings trade!
Now this is something I wanted to talk about because almost all new traders get this type of trade wrong, searching for earnings trades in the wrong companies, at the wrong times, and for the wrong prices.
Never fear, Merlin shall guide thee to the sensible and wise path, as always, and of course, and so on and so forth, and what have you.
When looking to do an earnings trade there are certain things to look for which may indicate the time is right to enter a trade. There are also certain times, in relation to the timing of the earnings announcements themselves, when the trade may be appropriate.
I will start with the latter; what times to trade earnings.
You do not, almost ever, want to buy options going into the month of a companies earnings report and especially not THE DAY or week of the report. The reason for this, is that the options markets “price in” a large price spread that they think may encompass the range a stock’s price will trade after earnings. So if the market thinks the stock will move +/-20 points, then the options put that expectation into the price of options via the “implied volatility“. This in turn makes the price of the contracts go up because option “premiums” are price based on the implied volatility of the stock, which goes up into earnings due to the large expected price swings mentioned above.
You do not want to be buying something when the price has been artificially driven higher by an earnings report.
The only way to play a company’s earnings report if you are bullish on the chart or fundamentals, is to wait until the morning after the report. The reason is because that artificial price I mentioned above is immediately sucked out of the price the minute the market opens with the earnings information out and disseminated.
This gives you an immediate massive discount to take advantage of if you think the report will eventually bring on strong movement in the stock. I have used this strategy many times over the years and it is one of my absolute favorite. Hopefully I get a chance to do a trade like this real-time for you in the future.
Next; Clues that can tell you when to buy before and earnings report.
Above I spoke about the implied volatility. This is such an important indicator to be following and have on your charts. When a companies implied volatility is at a remarkably low level going into earnings, and the company usually has very high implied going into earnings…oh boy, watch that ticker for sure. What this tells you is that nobody is expecting anything big to happen, and when no one is expecting anything, that is just the time you should be.
I know, crazy right, I am telling you that most people get the market wrong, never heard that here before right? (sarcasm dripping off sentence)
Take the implied volatility indicator out of your tool box and slap it on some charts. Find companies that usually have very high implied volatility going into earnings, but for some reason they do not this time. Then start doing the next steps to discover if there is something to take action on in the name.
What are those next steps you say?
You will find out in the Fourth Edition of this educational series which will be avialable to you in the near future.
I sincerely hope you have followed along with me throughout this series, and that you have gained a good insight into how myself and others are able to use options to produce some of the most fantastic gains possible in the stock market.
See you all next week for more trading and learning fun!