By Steve Levay of T3Live
You know that warm and fuzzy feeling you get during those special times of the year. There’s nothing like it. Mom and Pop go shopping for bargains, the experts forecast the hot new toys of the season, and some people, sadly, are left out in the cold while everyone else celebrates. Well, the weather is starting to turn and its beginning to feel like my favorite time of year……earnings season!!! There are many opportunites for a trader to make a lot of money during this time of year (apart from buying up the city’s supply of tickle-me-elmos). On the flip side, if you do not understand how earnings season works, you can also lose a lot of money. Here are my top 3 trading rules for trading earnings:
- BE PREPARED.
- It sounds simple, but always know what day the stock you are trading has earnings. Some traders get caught up in what they are doing and fail to plan properly for announcements in teh stocks they trade. For example, since I trade JinkiSolar Holding Co., Ltd. (JKS) every day, I know that JKS is supposed to report on November 15th. Also, know if any key stocks in that sector have earnings that could influence the movement in the stock you like to trade. That is very important. If you trade a stock every day and don’t know when they report earnings or when a competitor does, you are taking on more risk than you need to and could possibly blow your entire month up on something so easy to find out. You don’t want to be in JinkiSolar Holding Co., Ltd. (JKS) long and have First Solar, Inc. (FSLR) report terrible numbers and be down needlessly in JKS. For evidence, see the cloud computing names after the Equinix, Inc. (EQIX) adjusted guidance last week.
- KNOW THE STOCKS THAT YOUR STOCK TRADES WITH.
- I love to trade stocks off of other stocks news. For example, I love to trade Rare Element Resources, Ltd. (REE) when Molycorp, Inc. (MCP) goes up or down on any type of big volume push. I generally never touch the ACTUAL stock that has earnings, but I trade other stocks in the sector that trade with it. For example, if First Solar, Inc. (FSLR) gaps up $20 on great earnings, you can guarantee that I am going to get long LDK Solar Co., Ltd. (LDK), Canadian Solar, Inc. (CSIQ), Yingli Green Energy Holding Co. Ltd. (YGE) and anything else solar I can get my hands on. It takes the bigger risk out of the trade. Trading FSLR without news is already a risky proposition, but imagine trying to trade it when it moves 15 dollars up and down in 2 minutes. That’s why I use the actual earnings play as a guage for the other stocks in that sector. Again, it takes the greater risk out of the equation.
- DON’T OVERANALYZE NUMBERS.
- I have found myself numerous times trying to figure out why my stock had “great numbers and great guidance” only to get beaten down by the market. Always pay attention to how the market receives the numbers. If they want to sell a stock, they are going to sell it. Plain and simple. Many large market players use earnings whispers and announcements as a way to take profits or unload large amounts of stock. You will often see a stock run higher into an announcement, beat estimates and top-line, but trade lower. This is an example of profit takers using rumors to sell high and exit a position. Steve Levay is not going to keep the powers that be from pushing my stock down $3, even if I believe it should be much higher. We are not being paid to be guessers, we are being paid to make money on the movement in the stock. This is perhaps the most important concept for a trader to understand when trading earnings.
Following these rules, I have enjoyed consistent success trading during earnings season. The opportunites are seemingly limitless and it gives you many chances to make money in a market that, quite frankly, doesn’t move that much during the day right now. Again, it all comes down to discipline and preparation. Using my Fightin Phils as an example, a player like Roy Halladay analyzes video on every batter he is going to face. It means nothing to him that he just threw a no-hitter in his first ever playoff game a week ago. He knows that it’s a different day maybe even a different team. He needs to be prepared every day for every player. Just like in trading, being prepared and knowing the other players will give you the ultimate edge.
Let me tell you a strategy I have been using for years trading earnings using options. I average anywhere from at least $1,500/week but make on average o$3,500/week and sometimes much more by using this constantly and I never break from it.. My initial bankroll is always $10,000 a week. I never go higher than that. So here it goes:
During the week prior to earnings of companies listed for the following week, I print up the companies that are due for that entire week, usually from http://www.optionsxpress.com (my brokerage) which has Zacks’ info on their earnings calendar link. I immediately go from Monday-Fri and cross off all non-optionable stocks, pink sheet stocks, etc.. From here I circle the companies that have a consensus estimate EPS higher than the previous quarter by a decent enough amount to warrant a closer look. To note, I will not use this strategy on any stock that is under $20.00/share. It’s simply not worth the investment, imo. Anyways, after identifying the stock with projected higher earnings than last quarter, I see what the options prices are going for in the bid/ask. I almost only use options that are at-the-money (ATM), but will go a little bit out of the money (OTM) by a few dollars if I feel the price is simply too good to pass up. As an example, a couple of weeks ago Adobe met my standards and I immediately liked the prices. The stock price at the time of placing the trade was $32.78. I saw that a November put option with a strike of 31 was going for $0.69. Now, my strategy always buys 10 puts on a particular company (one can do more or less, but I like this amount as it gives me versatility). So, after the closing bell I patiently waited for the earnings to be released. Of course the report looked fine on paper, but this hardly matters to investors. It is a percentage game. For a stock to go up, way too much has to go right. For it to go down, it takes only something minor- and this is exactly what happened. After the bell, the stock sold off big-time. It was down $4.00+ within 20 minutes, and I knew it was going to be a good day the following morning. I had 7 companies reporting that day that I played. I hit on only 2/7- a low average. Yet, I walked out that day with a $4,500 gain including my commission costs. This happens all the time. During an average earnings season, I will play about 23 companies a week. What is important in this strategy is the discipline in sticking to the system and spotting underpriced options relating to the stock price. If the options seem too overvalued, don’t bother playing it- there are many more out there. Good luck all.