July 8th, 2022

How To Trade Earnings

I’m wrapping up a review of the first six months of this year and will share it early next week.  Stay tuned for that report.  I’ll also have some ideas for what we could see during the second half of the year. 

As far as the first week of the new half, we’ve had a nice gain, despite the negative economic numbers coming out.  Unemployment unexpectedly rose 4,000 to 235k, showing a weaker labor market than the expected 230k.  The May trade deficit of -$85.5 billion was wider than the estimated -$84.7 billion, which has negative GDP implications.  Should the GDP numbers go negative another quarter, we’d technically be in a recession and that may also drive markets lower.  

Last quarter we had a number of companies adjust their guidance to be lower, so as we get into the thick of earnings in the next couple of weeks, we will see if companies can beat expectations or if they come up short, which would more than likely lead to another leg lower in the overall market.  

Speaking of earnings, do you know that stocks can have the majority of their stock move happen around their earnings report each quarter?  Traders who want to take advantage of the extreme moves can use an options strategy that potentially allows them to profit, no matter which direction the stock price moves.  

Keep reading if you want to learn how to trade options around earnings season.  

The majority of the companies will be reporting the first two weeks of August, but next week we have some major banks kicking things off.  Companies like JP Morgan (JPM) and Comerica (CMA) are both reporting next week and both are expecting to show revenue growth.  

Here’s a chart breaking down the percentage of companies reporting each week over the next month and a half.

The SP500 is stuck in this wedge pattern and the question is if earnings will help elevate the market out of the wedge or if we break under the wedge due to more negative news and lower projections for future quarters.  We’re currently coming up to the previous swing high and could see some resistance at this level.  If we can break through the previous swing high, we could go up to challenge the upper wedge line.  

Ok, now on to the Straddle Options Strategy.  

The straddle is a strategy that involves the purchase of both a put and call option for the same expiration date and strike price.  Since you are buying both a call and a put, the stock has to have a significant move in one direction.  As a position, you can be profitable, but if the stock goes up, the value of the call will go up and the value of the put will decrease.  A straddle will have a winning leg and a losing leg of the trade.

It’s easy to pull examples of when this strategy works, but the risk is that you don’t know how the market will react to an earnings report.  Sometimes the stock barely moves and other times it takes off in one direction.  

One thing you can do is open a chart and look for earnings dates and see how much the stock typically moves during earnings.  If a stock moves 1% with each earnings announcement, it may not be a big enough move to make the straddle work.

Remember that the market makers also know how much the stock is expected to move and will price the long call and long put accordingly.

Netflix has lost around 25% or more during the last two earnings reports and they have earnings coming up on 7/19.  

The closer to earnings you get, the more expensive the options will be, so buying 2-3 weeks out before earnings can cut down on some costs.  Before you place your first straddle trade, go back and experiment with different days to expiration to see how they would have done.  The smaller days-to-expiration strikes will move more than longer-dated options.  

For illustrative purposes, I’ll show you a current straddle on Netflix (NFLX).

Ticker: NFLX

Buy to open July 29 22 $190 CALL

Buy to open July 29 22 $190 PUT

Total cost (debit): $3118 per straddle

Here’s the risk graph, where the blue line is the profit line at expiration.  Since you are buying two options, you can see that we need the stock to move from $190 to about $220 or $157 before the straddle makes money.  That indeed is a big move!