from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up

1-800-803-4595

Stock Option Strategy for an Earnings Announcement

One of the best times to use an options strategy is just before a company makes its quarterly earnings announcement.  That is the time when puts and calls get very expensive.  When the earnings come out, investors are usually disappointed or elated, and the stock price often makes a big move.  That is why those puts and calls are so expensive just prior to the announcement.

Since our favorite stock options strategy is to sell options just before expiration, the pre-announcement time is often the perfect time to take action.  Today I would like to share a recommendation I made to paying subscribers over the past weekend.

Terry

Stock Option Strategy for an Earnings Announcement

Keurig Green Mountain (GMCR) has had quite a year, more than doubling in value.  Coke came along at the beginning of 2014 and bought a billion dollars’ worth of GMCR stock (and so far, they have picked up a billion dollar profit – not bad).

On Wednesday, November 19, GMCR announces earnings, two days before the November expiration for stock options.  Option prices are sky high – implied volatility (IV) for the November series is 67 compared to 44 for the January series.  While all the option prices will fall after the announcement, the risk profile graph shows unusually high possible gains at almost any higher price with the spread suggested below, and the stock can also fall by a large margin and gains should result as well.

An interesting way to play this earnings announcement would be to buy a December 140 put and sell a November 150 put.  You could do it at credit of about $1.80 (and with a $1000 maintenance requirement, your net investment (and maximum theoretical loss) would be $820 per spread).  Check out the risk profile graph assuming that IV for the December put would fall by 10 after the announcement (it probably won’t fall that far).

GMCR Risk Profile Graph November 2014

GMCR Risk Profile Graph November 2014

No matter how high the stock goes, there will be a gain because the 150 put would expire worthless, and the stock could fall $12 before a loss would result on the downside.  I like those odds.

Maybe you are a little more bearish on the stock (the whisper numbers for earnings are about 10% higher than analysts’ projections which means that expectations may be too high, and a lower stock price may come about because of those expectations).  In that case, you might consider buying a December 135 put and selling a November 145 put.  You could collect about $1.10 for the spread and risk $890, and the risk profile graph would look like this (again assuming IV for the December put will fall by 10):

GMCR Risk Profile Graph 2 November 2014

GMCR Risk Profile Graph 2 November 2014

The downside break-even point is about $140, or almost $13 lower than the current price, and a gain of some sort will accrue at any price above $145 because of the intitial credit and the fact that the put will expire worthless (and there will be some residual value with the December 135 put).  This looks like a pretty secure way to make 10% (or maybe a whole lot more) in the next two weeks. A profit should result if the stock does anything other than fall by more than 8% after the announcement.  The maximum gain would be about 30%, and would come if the stock fell by about $8 after the announcement (and some sort of gain would come no matter how high the stock might go).

Note: GMCR has gone up about $2 in early trading today, and the above spreads we discussed in our Saturday Report would net slightly less if you placed them today today (i.e., your investment would be slightly higher than the above numbers).

Update on the ongoing SVXY put demonstration portfolio.  This sample demonstration portfolio holds a SVXY Mar-15 70, and each week, (almost always on Friday), we buy back an expiring weekly put and sell a one-week put in its place, trying to sell at a strike which is $1 – $2 in the money (i.e., at a strike which is $1 or $2 above the stock price)  Our goal in this portfolio is to make 3% a week.

Last week, SVXY rose about $3, and we bought back the expiring Nov1-14 70 put (then out of the money) and sold a Nov2-14 73 put, collecting a credit of $2.53 ($250.50 after commissions).  That made our long Mar-15 70 put $3 below the strike of the put we had sold, and the broker would assess a $300 maintenance call.  We could have handled that because we had over $600 in cash in the account, but we decided to roll the Mar-15 70 put up to the 75 strike, (buying a vertical spread).  We paid $2.55 ($252.50 after commissions).  We can now sell weekly puts at strikes as high as 75 without incurring a maintenance requirement.

The account value is now $1445, up $211 from the starting value of $1234 on October 17th ,3 weeks ago.  This works out to $70 a week, nearly double the $37 weekly gain we need to achieve our 3% weekly goal.

I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week, although I will not report every trade immediately as I make it.  I will follow the guidelines for rolling over as outlined above and earlier, so you should be able to do it on your own if you wish.

Tags: , , , , , , , , , , , , , , , ,

Making 36%

Making 36% — A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

Order Now

Success Stories

I have been trading the equity markets with many different strategies for over 40 years. Terry Allen's strategies have been the most consistent money makers for me. I used them during the 2008 melt-down, to earn over 50% annualized return, while all my neighbors were crying about their losses.

~ John Collins