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Fellow Investors & Traders,
Today we are going to talk about another strategy that I’ve used to
make profits from the special ‘Earnings Date” event.
There are two specific stock option
strategies called “Straddles” and “Strangles” that allow you to have
a “CALL” position and a “PUT” position at the same time for the same
stock symbol.
The simple idea behind these
strategies is to be in position when you expect a big price move on
the underlying equity stock. Generally, we see big price swings just
after the company reports quarterly earnings (the next day). The price swings can be to the
upside or to the downside depending on what the company says about
their quarterly results (and future forecast).
The advantage with “Straddles” and
“Strangles” is that your positions will already be in place before
the stock price moves, one way or the other (up or down) – that is when
you take advantage of the price moves to make your profits.
Companies can often have great
quarterly earnings results, but the future forecast statements (or
any negative news) can send the stock price crashing down the next
day. So, using the Straddles and Strangles strategies can help take
advantage of these type price swings and give you a better
opportunity to profit from the price moves on either side.
Here’s how “Straddles” work!
Let’s say you want to get in on the
potential stock price move of Google Inc. before the company reports
their next quarterly earnings report and pick up some stock options
ahead of the news. With the “Straddle” strategy you would be buying
at least 1 “CALL” Option and at least 1 “PUT” Option at the same
strike price, on for the same stock option symbol, with the same
expiration timeframe. That’s
how the straddle strategy works.
Your plan is to have a position on both sides of the
investment so that when the anticipated price move occurs you will
have an opportunity to make money on whichever side has the greatest
move up in price above your “break-even” point.
After the earnings news is released,
generally there will be a significant price move to one side or the
other , that is when you decide which position to close out. Take your profits on the positions
that is now profitable, or let it continue to run higher if you think
there is more upside to come based on the earnings information and
sentiment.
One major thing to consider is to
understand the “characteristics” of how the particular stock price
generally moves on a regular basis. Is it a highly volatile stock
(fast price moving stock up or down) – Ex. GOOG)) or is it a slow moving stock (Ex.
ORCL)?
The best stocks to use these
strategies on are the “high volatile stocks”. These stocks have a tendency
to have big price swings from week to week and especially around the
quarterly earnings date.
Here’s how “Strangles” work!
Strangles work in the same manner as
straddles, except you buy a “lower” strike price “PUT” Option
contract.
With the “Strangle” strategy you
would be buying at least 1 “CALL” Option and at least 1 “PUT” Option
at a “lower” strike price, on the same underlying stock symbol, with
the same expiration timeframe.
That’s how the strangle strategy works. Your plan is to have a position on
both sides of the investment so that when the anticipated price move
occurs you will have an opportunity to make money on whichever side
has the greatest move up in price above your “break-even” point.
The next important decision is to
decide which “Call” or “Put” Option to buy for this type of situation.
You will have to decide this based on the amount of money you are
willing to spend on each of the options. Stock option strike prices that are close
(near-the-money) to the current share price will be more expensive
than the stock option strike prices that are less (or more) than the
current share price (out-of-the-money), so you will need to do some
calculations on how much your costs would be to determine what you
can afford and what your potential profits would be.
Let’s take a real example and put it
all together using Sears Holdings Corp (SHLD).
Before we get into the details of
our SHLD example - - Let me
tell you another important
detail about stock prices that can occur before the company
earnings date. 90% of the
time the share price of a company scheduled to report earnings will
rise in price starting 1 week (or a few days) before the earnings
date. That is when most of
the volatility ahead of earnings will occur – and that is what the
share price of Sears Holdings Corp did also before the 2007 3rd
quarter earnings report date.
The share price for SHLD was around
$107 on 11/26/07, then traded up over the next 3 days to over $116 by
11/28/07. The company
earnings report was scheduled for the next day 11/29/07 (before the
market opened). So, this was
a great example of how market makers let the price biding run up
ahead of special events based on supply and demand.
If you had purchased some stock
options ahead of the earnings date – that is when you would close out
most of your positions to lock in those profits. If you think the earnings
information will be good enough to continue boosting the share price
after the news, then you might want to keep 1 (or a few) “CALL”
option contracts in place to capture more profits if the share price
breaks out to the upside after the news – that is when your “CALL” options
would increase in value also.
If the share price drops, then you only have the potential to
lose the investment for those “CALL” options you still hold.
Now, back to the Sears Holdings Corp
example. The next day as the company released the earnings news the
share price dropped from $116 (the previous day closing price) down
to under $98 due to the negative earnings numbers reported for the 3rd
quarter. The retail sector
stocks were really having a hard time generating earnings and revenue
due to the credit/subprime housing issues, so it was not surprising
that the earnings news was disappointing.
There were several stock option
contact strike prices available for Sears Holdings Corp. I decided to
look at the “Dec 125 CALL Option” (for the potential upside move) and
the “DEC 100 PUT Option” (for the potential downside move).
The “DEC 125 CALL Option” was priced
around $2.50. The “DEC 100 PUT Option” was priced around $1.55. These were two “low-cost” stock
options that I was willing to purchase to have positions in place to
take advantage of whichever side had the largest price move after the
earnings news announcement.
The reason I picked these two
specific options is mainly due to the “low-cost” value and the price
difference between the two was around .95 cents. Based on the
characteristics of how SHLD generally trades after earnings I
expected a big price swing to one side or the other which would cover
the difference between the values and I would have a small limited
amount of risk with a high probability that the gains would be much
greater.
Here’s the break-down cost for the
two positions.
The “DEC 125 CALL” (3 contracts @ $2.50)
would be approximately $764.95
The “DEC 100 PUT” (3 contracts @
$1.55) would be approximately $479.95
Both of these transactions would
be “Buy To Open” (for
the action) when you first initially buy the contracts. When you want
to close the positions, the action would be “Sell To Close”.
So,,,here is what happened! After
the earnings news was released the “CALL” Option price fell to .30
cents, but the “PUT” Option value gapped up to over $6.00 (from
$1.55).
Closing out the “Call” Option
position @ .30 cents would present a loss of approximately $689.90
Closing out the “PUT” Option
position @ $6.00 would present a gain of approximately $1305.10
Overall, these two transactions
provided a real profit of $615.20! This is one way to manage stock
price movement on company earnings with high volatile stocks. No one
knows which way the stock price will go after the earnings news is
released, but this strategy can give an investor the opportunity to
potentially capture a big price swing no matter which way the stock price goes (up or down)!
Here’s a screen shot of exactly how
the calculations would look! Click
Here!
Here’s another example of “Strangle”
positions for AZO (AutoZone Inc.) before and after the 2007 December
1st quarter earnings (12/04/07)! Click
Here!
What are some good company stocks to
watch for potential “Straddle” and “Strangle” Stock Option Buys? Glad you asked! Here are my top companies that I
follow for potential 2 sided positions to capitalize on volatile
price movement around company quarterly earnings.
AAPL (Apple Inc.)
AMZN (Amazon.com)
AZO (AutoZone Inc.)
EBAY (EBAY Inc.)
BIDU (Bidu.com Inc.)
BCSI (Blue Coat Systems Inc.)
CMG (Chipotle Mexican Grill)
CMI (Cummins Inc.)
DE (Deere and Co.)
Deck (Deckers Outdoors Corp.)
DRYS (Dryships Inc.)
FSLR (First Solar Inc.)
FWLT (Foster Wheeler Ltd)
GOOG (Google Inc.)
GRMN (Garmin Ltd)
ISRG (Intuitive Surgical Inc.)
LVS (LAS Vegas Sands Corp)
MA (Mastercard Inc.)
MON (Monsanto Co.)
PCLN (Priceline.com Inc.)
RIMM (Research In Motion)
SHLD (Sears Holdings Corp.)
SPWR (SunPower Corp.)
VMW (VMWARE Inc.)
WYNN (Wynn Resorts Ltd)
X (United States Steel)
Another thing to consider that could
give you one more advantage when the share price gaps up really high
after a good quarterly earnings report is to watch what happens 1-3
days later. Generally, there will be some “profit taking” and the
share price will once again start to trade down.
That is a good time to go back with
a “PUT” Option and capitalize on the share price heading lower
because the news event is now over and investors are starting to take
profits and sell shares. When
this starts to happen, the “PUT” option prices generally trade up in
price giving you more opportunity for profit as the price falls.
So, how do you know when it’s a good
time to use the “PUT” Option strategy? The first thing you need to do is pay attention to
what’s going on in the stock market and understand what the market
trend is doing. Is the overall stock market trend going up (are stock
prices moving higher) due to good news events or is the stock market
trend going down (due to negative news events)?
If the overall stock market trend is
going down, that is when you look to use the “PUT” Option strategy.
Stock prices in general trade down more often than they move higher,
so using the “PUT” Option strategy can give you another advantage
when prices start to trade down.
When companies announce any type of
“negative news events” such as a bad earnings report, lawsuit events,
negative news about products or services – any of these negative
events can cause the stock price to start going down. That is when you look to use the
“PUT” Option strategy to take advantage of the stock price trading
down.
Note: See my special article “How
To Practice The “PUT” Option Strategy in the Free Education
section!
“Planning, “Timing” and some information
“Research” are the keys to making a good decision
to buy stock options (and which stock options to buy). Once you have everything setup,
looking for good stock option opportunities will be the main activity
to concentrate on.
Follow my weekly M.T.T. Quarterly Newsletter for some good
ideas to consider. Make notes of important dates for the companies
that you are considering (Ex.
Company Earnings Dates), keep up with company news events (which affect how the
stock price will react) and practice some different scenarios using
my Stock Price Calculation Program to help you see where your profit
or loss opportunities would be! This is a great tool to practice with
and get a feel for making real stock option buys! Take your time and
practice – this will give you the best opportunity to be successful
with either strategy you use!
If you have not taken the 7-Day
Free Trial! Download your free copy today -- play around
with some calculations and see how much simpler the program makes all
of your cost, profit and exit planning calculations.
See the 7-Day Free Trial link on the homepage! www.newstocksoftware.com
If you have any
questions or need some “one-on-one” guidance, let me know – I work
with stock options every week and continuously look for
opportunities.
To your
success!
Jimmie V. Smith
markettrading@juno.com
Copyright 2007
Market Trading Technologies
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