The Dow took a hit yesterday, dropping 100 points, after Goldman Sachs (GS) missed earnings expectations. Now this came as a major surprise to analysts and Wall Street – but more importantly, to anyone sitting and waiting to take profits on a seemingly easy trading opportunity.
And that’s exactly what I want to talk to you about…
The biggest threat to your portfolio during earnings is an unexpected result – like GS yesterday.
But the solution is actually quite simple.
And it has the power to deliver unlimited profits – on each and every trade…
How to Capture Unlimited Profits During Earnings Season
Typically, when companies make positive earnings announcements, it’s considered to be good news. This propels more buying, and that demand drives the stock up in price. The same is true for the reverse – when companies make negative earnings announcements, it’s typically deemed bad news. This causes a mass exodus of the stock, and the price drops quite a bit.
Note that I used the word “typically” above…
While both situations are the most common outcomes for positive and negative earnings, there are cases where bad news isn’t actually bad – and good news isn’t actually good. Take Wells Fargo (WFC), for example. They beat expectations, coming in at an earnings per share (EPS) of $1.00 versus consensus estimates of $0.97 eps – which you’d think is good news for the stock. But as I told the CNBC pundits last week, it’s actually the number one bank stock to avoid right now because of its uncertain future due to the misconduct scandal.
So how exactly do you trade around earnings without facing the risk of a completely unexpected outcome?
Use a straddle.
A straddle is an options strategy you’d use to profit during earnings season and also during times of market volatility. It involves buying both an at-the-money (ATM) call and an ATM put with the same strike price and the same expiration. An option that’s at-the-money simply means that the stock price and the option’s strike price are the same.
Straddles are actually the most popular way to play earnings and market volatility because they allow you to profit when the stock moves up or down. You can think of it like “straddling a fence,” having one leg on each side. And since there’s no limit to how high a stock’s price can go, your profit potential is virtually limitless.
When it comes to placing straddles before an upcoming earnings announcement, the best way to profit is to make your exit before the announcement’s made. Likewise, if you’re placing a straddle after earnings come out, then the best way to profit is exit your trade within a few days after earnings – especially if there was no major movement in the stock. But if you’re newer to options, your safest bet is to get in and get out before earnings.
Here’s a “cheat sheet” you can use:
| Straddle
What it is: An options trading strategy where you buy an ATM call and an ATM put with the same strike prices and expiration dates – at the same time, on the same order ticket
When to use: In volatile markets and during earnings season
How to profit: When the stock (or other underlying security) moves either up or down
Maximum risk: The net debit paid (cost of both the call and put)
Maximum reward: Unlimited
Pre-earnings straddles: Exit before earnings come out
Post-earnings straddles: Exit within a few days after earnings come out |
Now next week, we’ve got Amazon.com Inc. (AMZN) and Microsoft Corporation (MSFT) releasing earnings. So you’ve got the perfect opportunity to capitalize on the stocks, no matter how good or bad the results are.
We’ve also got Apple Inc. (AAPL) due to report earnings in two weeks.
And on Friday, I’ll show the best way to play the stock.
So stay tuned…
Tom Gentile
