The anticipation of volatile stock movements can instill fear in the most weathered stock trader. Market mavens tout stock picks prior to earnings announcements and with abandon, these “hot tips” are disseminated through media channels. Just look at the all the predictions on stocks that are moving higher based on anticipation of the event, to only have to event come and not meet expectation, causing the stock to lose ground.
In spite of growing concerns about the global economy, the market continues to march steadily higher. This is driving to a market that feels a little over bought, but continues to do well. The main drivers this week have come from a barrage of earnings that for the most part have been good. IBM, Microsoft, Intel all beat analyst expectations.
Google, on the other hand missed their estimate badly on both earnings and sales. The reason for the miss was both increasing costs and well as some foreign currency issues. GOOG was down $53.57 a share, to close at $586 on Friday. JPM, C and GE also contributed to the weak performances with their respective reports.
There were plenty of positives out of the conference calls at IBM, Microsoft and Intel. Microsoft CFO Peter Klein, for example, said that business spending is helping them deal with a weak PC market. “The overall business environment remains strong for us,” he said. Revenue from MSFT’s Server and Tools business grew 11% year over year, driven by strength in Windows Server, SQL Server premium, Exchange and SharePoint products. Some of the biggest growth came from their Xbox division as well as its Lync communications software and Dynamics CRM. The only weakness in MSFT’s report was the slowdown in Windows sales, but much of this can be attributed to a release of Windows 8 later this year and companies waiting for that release before they go through an IT spending cycle.
Intel was also very optimistic about the economy and the PC market. “I haven’t seen this level of excitement in the customer base since 2003,” said Intel CEO Paul Otellini, explaining that more than 70 ultrabooks will launch this spring. “People are very excited about the feature set and having the PC re-energized.” IBM, as always, continues to operate well. Its results show some concern over Europe, but still come in very solid on both revenue and earnings.
This kind of mixed picture has some “equity only” investors very nervous. Sophisticated options traders, on the other hand, know exactly how to profit from these potentially hazardous announcements. Options traders are not constrained by choosing direction correctly. In fact, through application of a straddle or even a ratio spread, the challenge is to identify not only the direction, but the time-frame required for the stock to move beyond a certain range. Since earnings season is often synonymous with “volatility season” these strategies afford the options trader a fantastic opportunity to profit irrespective of the stock direction following earnings announcements.
Take Netflix (NFLX) as an example. Any Chartist looking at the stock over the past 6 months will tell you the stock has been VOLATILE. The stock had been as high as $260 and as low as $62. This last week NFLX hovered at its $100 resistance level, approaching earnings on Wednesday. A straddle at strike 100 in June will cost about $36. Using the TradeMonster analyze tool we can see that if the stock now moves more than $10 from strike 100 the trade will be profiting. What is the chance that a stock that has moved over $200 over the past 6 months will move more than $10 in the next 5 months? The answer appears to be high though there is never a guarantee.
For those that like to realize profits in a shorter time-frame, a ratio spread in February is possible. A short call at strike 100 with twice as many long calls at strike 120 would generate a $2.55 credit thereby requiring a $1.30(neglecting time value) move above $121.30 or to stay below strike 100 to yield a profitable trade prior to options expiration. Is this hedged trade more attractive than betting solely on the stock rising or falling?
If it seems to make sense, then next time you hear a recommendation prior to earnings, take a look at a stock chart, look at the range of the stock, and look at the options strategies mentioned above. If the arithmetic works then you might have just found a high yielding trade that can be applied four times a year prior to each conference call to make BIG money.
OptionsANIMAL Founder & CEO