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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.)
CMG (Chipotle Mexican
Grill)
CMI (Cummins Inc.)
DE (Deere and Co.)
Deck (Deckers Outdoors Corp.)
FSLR (First Solar
Inc.)
GOOG (Google Inc.)
ISRG (Intuitive
Surgical Inc.)
MA (Mastercard Inc.)
PCLN (Priceline.com
Inc.)
SHLD (Sears Holdings
Corp.)
VMW (VMWARE Inc.)
WYNN (Wynn Resorts
Ltd)
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 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
2010 Market Trading Technologies
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