Trading Options Around Earnings Reports

| April 7, 2008 | 0 Comments

A few years back I was hunting in Montana with a good group of guys. Honestly, I’m not much of a hunter.  But I enjoy being outdoors in very beautiful places.  I also like the camaraderie one finds with a group of men all on a common mission.

What I remember most were the stories and tips that everyone shared. Sitting around a warm fire on a cold night everyone seems to have something to contribute.  This is where the knowledge from generations of hunters gets passed along.

I’m about to go hunting today . . . but not for deer.  Today I am hunting profits.

Earnings season officially starts today.  Alcoa (AA) announces earnings this afternoon.  They’re always the first to report and I’m sure they’ll do so in grand style.  For the next few weeks, the financial world will be focused on a steady stream of news and numbers.

Another event is happening right now as well.  Like a pack of wolves, options traders everywhere are starting to salivate.

This time of year – earnings season – is when really big profits can be made in options.  If you know what you’re doing.

So in the spirit of hunters everywhere, gather round the fire.  I’m going to share with you a few important tips and tricks.  These ideas are all focused on trading options during earnings season.  One of these might help you capture that big buck! (pun intended)

The Importance of Volatility

This may seem a little backwards, but trust me.  The more volatile the markets, the better it is for your option trades.  The market over the last few months has been extremely volatile, which makes this earnings season all the more lucrative.

Now, I know what you’re thinking.  Why do we like volatility?  We like volatility because it causes big moves in stocks.  When you buy an option, you want the biggest move possible, in the shortest amount of time.  These big moves help amplify your profits.

Think of it this way.  If GE makes an important announcement, the stock might move (up or down) $3, $4 or even $5.  If Google makes an important announcement the stock might move up or down $30 or $40 or $50 points!  I bet you can guess which set of options I’d rather own.  So secret number one is look for stocks with lots of volatility.

The Importance of Estimates

The importance of understanding Wall Street earnings estimates is overlooked by many new option traders.  Every company reporting (at least those worth paying attention to) has an earnings estimate.  This number is one of the most important numbers to know.  If a company beats their estimates the stock could rally.  If they miss . . . watch out below.  Either way, understanding that number is very important.

Except . . .

The only thing that can be more important than earnings numbers is management comments about the future.  Earnings are strange.  You might get a company who beats their earnings estimate and the stock falls.  You might see the exact opposite where a company misses estimates but the stock rallies.  What causes this?  Management comments about the future.

Let me give you an example.

Commodities have been trending upward for the last few years, but they recently pulled back.  Investors are starting to wonder if this pullback is the end of the run or just a breather on a climb to higher levels.  Earnings are less important for companies tied closely to the commodity sector.  Everyone is going to focus on management comments about the future.  Secret number two is to know the earnings estimates. . . and when to ignore them.

I’m cheating on this last secret.

I actually gave this away some time ago and a lot of people made money from it.  So here it is again.  Pay very close attention to earnings announcements of other companies in the industry.  Sounds simple but lots of investors overlook the obvious.

A few months ago, I noticed solar stocks were jumping higher on earnings announcements.  I knew that if one or two companies had really strong earnings the others probably did as well.  Sure enough the first few announced big quarters and record backlogs.  Everyone in the industry was doing really well . . . and those who were watching closely made great money trading the options.

One last thought.  If you’re trading options based on earnings announcements pay very close attention to your positions.  This is not the time to turn a short term trade into a long term investment.  Watch the stock and have a trading plan.  Know why you are buying something and always have an exit.  If a trade moves against you for whatever reason, get out.  Preserve your capital and look to trade something else. Wishing and praying that a trade turns around once the announcement has been made usually doesn’t work in your favor.

I sincerely hope these tips and tricks help you capture that big buck. Happy hunting!

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Category: Stocks

About the Author ()

The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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