Options for Earnings Plays
Know the expectations.
Before getting to some of the concepts and strategies that can be employed in playing earnings reports, let me provide the caveat: All earnings plays are extremely speculative and should only involve a minimal allocation of risk capital. The challenge in trading earnings is that there are many variables that need to be accounted for and correctly forecast.
Not only must you determine if the company will meet estimates (and whether those estimates recently been lowered or raised) and what kind of guidance will be provided, but you also must determine what has already been priced into the stock, and whether it has recently run up or sold off. And most importantly for our purposes, you must determine what percentage price move the options are pricing in as measured by their implied volatility (IV).
For example, look at UnitedHealth Group (NYSE:UNH) this morning. Despite delivering better-than-expected results and a mostly positive outlook, shares are off some 2% at the opening. Is this sell-off simply a pullback after a nice run in which UnitedHealth had rallied some 12% since being added to the S&P 500 Index (INDEXSP:.INX) one month ago -- or is it a sign that investors are truly concerned? Will Google (NASDAQ:GOOG) -- whose stock has run up approximately 27% during the past six weeks -- suffer a similar sell-the-news reaction following its earnings report this Thursday?
Imagine the game of "what is baked into" Apple's (NASDAQ:AAPL) earnings next week with the ingredients including its recent 10% sell-off, the speculation surrounding the iPad mini release, and iPhone 5 sales. I expect the implied volatility for Apple options, which have already increased by 25% to 38% over the past two weeks, to be near 52- week highs, and near 43% by the time it reports next Thursday. And then -- no matter what the results or response -- expect implied volatility to decline back towards the mid-30s level.
Prepare for Post-Earnings Premium Crush
The tendency for a post-earnings premium crush (PEPC) to occur makes understanding the relative "expensiveness" of options and the magnitude of the price move being priced in crucial to improving the probability of achieving a profitable trade.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter