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Archive for the ‘Earnings Announcement Options Strategy’ Category

Palo Alto Networks (PANW) Breaks to Record Highs, What’s Next?

Sunday, July 15th, 2018

This week we are looking at another of the Investor’s Business Daily (IBD) Top 50 List companies.  We use this list in one of our options portfolios to spot outperforming stocks and place option spreads that take advantage of the momentum.

Terry

Palo Alto Networks (PANW) Breaks to Record Highs, What’s Next?

Palo Alto Networks has seen a remarkable rise in its stock price over the last few years and several articles on The Motley Fool suggest there will be further upside.  Here are the latest two – Palo Alto Networks’ Bull Run Probably Won’t Be Ending Anytime Soon and Forget Cryptocurrencies: You’re Better Off Buying These 3 Stocks.

On a daily chart, PANW appears to be consolidating in a range since around the middle of May.  However, a closer look reveals a notable technical break.  Range support near $200 wasn’t just important because of the psychological implications, the level also triggered a sharp turn in 2015 that led to a two-year correction.  Although there have been marginal breaches below the level since the stock price initially climbed above it a few months ago, bears have been unable to drive the stock price below it on a sustained basis.  To the upside, resistance near $216 had capped rallies in June but the recent bullish break of the level suggests the uptrend has resumed.

PANW Chart July 2018

PANW Chart July 2018

*source Tradingview.com

If you agree there’s further upside ahead for PANW, consider this trade which is a bet that the stock will continue to advance over the next six weeks, or at least not decline very much.

Buy To Open PANW 24AUG18 212.5 Puts (PANW180824P212.5)
Sell To Open PANW 24AUG18 215 Puts (PANW180824P215) for a credit of $0.95 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when PANW was trading near $216.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

Your commission on this trade will only be $2.50 per spread (the rate charged by thinkorswim for Terry’s Tips’ subscribers).  Each contract would then yield $92.50 and your broker would charge a $250 maintenance fee, making your investment $157.50 ($250 – $92.50).  If PANW closes at any price above $215 on August 24, both options would expire worthless, and your return on the spread would be 59% (552% annualized).

Changes to Investor’s Business Daily (IBD) Top 50 This Week:

IBD Underlying Updates July 12, 2018

IBD Underlying Updates July 12, 2018

We have found that the Investor’s Business Daily Top 50 List has been a reliable source of stocks that are likely to move higher in the short run.  Recent additions to the list might be particularly good choices for this strategy, and deletions might be good indicators for exiting a position that you might already have on that stock.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

Micron Technology (MU) Dips To Support, Is It a Buy?

Sunday, July 8th, 2018

This week we are looking at another of the Investor’s Business Daily (IBD) Top 50 List companies.  We use this list in one of our options portfolios to spot outperforming stocks and place option spreads that take advantage of the momentum.

Terry

Micron Technology (MU) Dips To Support, Is It a Buy?

Micron Technology stock has been impacted by negative headline news as of late but these following two articles make a strong case for why this news is not likely to cause bearish pressure for the stock price moving forward.  Micron’s China Woes May Not Be the Disaster Investors Thought and Micron Technology is rebounding after saying China ban will have minimal impact.

MU has been correcting lower since the end of May but is seen trading near an important technical inflection point, and has already shown signs of buyer’s protecting the area.  The support area is derived from a rising trendline that originates back to a low printed in August last year as well as a horizontal level at $49.62.  The rising trendline last triggered a bounce in May which led to a break to record highs.  The horizontal level carries psychological properties as it falls near $50.  The level acted as major resistance in late 2017 and is now seen as support.

MU Chart July 2018

MU Chart July 2018

*source Tradingview.com

If you agree there’s further upside ahead for MU, consider this trade which is a bet that the stock will continue to advance over the next six weeks, or at least not decline very much.

Buy To Open MU 17AUG18 50 Puts (MU180817P50)
Sell To Open MU 17AUG18 52.5 Puts (MU180817P52.5) for a credit of $0.98 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when MU was trading near $53.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

Your commission on this trade will only be $2.50 per spread (the rate charged by thinkorswim for Terry’s Tips’ subscribers).  Each contract would then yield $95.50 and your broker would charge a $250 maintenance fee, making your investment $154.50 ($250 – $95.50).  If MU closes at any price above $52.50 on August 17, both options would expire worthless, and your return on the spread would be 62% (580% annualized).

Changes to Investor’s Business Daily (IBD) Top 50 This Week:

IBD Underlying Updates July 5, 2018

IBD Underlying Updates July 5, 2018

We have found that the Investor’s Business Daily Top 50 List has been a reliable source of stocks that are likely to move higher in the short run.  Recent additions to the list might be particularly good choices for this strategy, and deletions might be good indicators for exiting a position that you might already have on that stock.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

Consider Integrated Device Technology (IDTI) Following the Correction

Sunday, July 1st, 2018

This week we are looking at another of the Investor’s Business Daily (IBD) Top 50 List companies.  We use this list in one of our options portfolios to spot outperforming stocks and place option spreads that take advantage of the momentum.

Terry

Consider Integrated Device Technology (IDTI) Following the Correction

Several analysts are expecting further upside for Integrated Device Technology, here are two of them – What the market is missing about Integrated Device Technology and Two worthy stocks for investors: Hovnanian Enterprises, Integrated Device Technology.

IDTI Chart June 2018

IDTI Chart June 2018

IDTI has been correcting lower over the past two weeks and is now seen trading at some important technical support.  Specifically, the stock is seen bouncing from a horizontal level residing at $31.30.  This level was notably important through several gaps that took place in late 2017 and earlier this year.  As well, the stock price is near the 200-day moving average, an indicator it has not traded below on a sustained basis in about two years.

If you agree there’s further upside ahead for IDTI, consider this trade which is a bet that the stock will continue to advance over the next three weeks, at least a little bit.

Buy To Open IDTI 20JUL18 29 Puts (IDTI180720P29)
Sell To Open IDTI 20JUL18 32 Puts (IDTI180720P32) for a credit of $0.69 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when IDTI was trading near $32.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

Your commission on this trade will only be $2.50 per spread (the rate charged by thinkorswim for Terry’s Tips’ subscribers).  Each contract would then yield $66.50 and your broker would charge a $300 maintenance fee, making your investment $233.50 ($300 – $66.50).  If IDTI closes at any price above $32 on July 20, both options would expire worthless, and your return on the spread would be 28% (568% annualized).

Changes to Investor’s Business Daily (IBD) Top 50 This Week:

IBD Underlying Updates June 28, 2018

IBD Underlying Updates June 28, 2018

We have found that the Investor’s Business Daily Top 50 List has been a reliable source of stocks that are likely to move higher in the short run.  Recent additions to the list might be particularly good choices for this strategy, and deletions might be good indicators for exiting a position that you might already have on that stock.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

Consider IPG Photonics (IPGP) Following the Technical Breakout

Monday, May 14th, 2018

This week we are looking at another of the Investor’s Business Daily (IBD) Top 50 List companies.  We use this list in one of our options portfolios to spot outperforming stocks and place option spreads that take advantage of the momentum.

Terry

Consider IPG Photonics (IPGP) Following the Technical Breakout

In addition to being listed as one of the IBD Top 50 companies, Investor’s Business Daily recently wrote about IPGP, outlining the reasons why the growth stock is setting up for another advance.  Also take a look at this publication which discusses why IPGP is trending.

IPGP broke higher late last week from a bullish flag pattern that has been setting up for most of the year thus far.  Technical traders tend to keep a close eye on flag patterns, especially in assets that have had a strong trend which IPGP certainly displayed in 2017.  Technical support is found nearby from a horizontal level at $248 which marks last years high.  Also near the level is additional support from the top of the broken flag pattern.

IPGP Chart May 2018 credit spread

IPGP Chart May 2018 vertical spread

*source Tradingview.com

If you agree there’s further upside ahead for IPGP, consider this trade which is a bet that the stock will continue to advance over the next five weeks, or at least not decline very much.

Buy To Open IPGP 15JUN18 240 Puts (IPGP180615P240)
Sell To Open IPGP 15JUN18 250 Puts (IPGP180615P250) for a credit of $3.58 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when IPGP was trading near $151.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

Your commission on this trade will only be $2.50 per spread (the rate charged by thinkorswim for Terry’s Tips’ subscribers).  Each contract would then yield $355.50 and your broker would charge a $1000 maintenance fee, making your investment $644.50 ($1000 – 355.50).  If IPGP closes at any price above $250 on June 15, both options would expire worthless, and your return on the spread would be 55% (627% annualized).

Changes to Investor’s Business Daily (IBD) Top 50 This Week:

IBD Underlying Updates May10, 2018

IBD Underlying Updates May10, 2018

We have found that the Investor’s Business Daily Top 50 List has been a reliable source of stocks that are likely to move higher in the short run.  Recent additions to the list might be particularly good choices for this strategy, and deletions might be good indicators for exiting a position that you might already have on that stock.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

Diagonal Condor Earnings Strategy Update #5 – Mastercard (MA)

Tuesday, April 24th, 2018

When using the Diagonal Condor Earnings Strategy, one of the things we like to find is a stock about to announce earnings where the options have priced in a post-announcement price fluctuation which is greater than the historical average of the post-announcement changes for that company.

Our goal is to create two diagonal spreads at a credit (or slight debit) which allow for a profit to be made if the post-announcement fluctuation is within the historical average amount.  In the past few weeks, we have placed spreads that met these criteria on several companies, including Carmax (KMX), TD Ameritrade (AMTD), and Red Hat (RHT), and these plays were all profitable, with returns from 30% to over 70% including commissions in a single week.

This week, we are looking forward to taking a position in Mastercard (MA) which announces earnings before the market opens on May 2.  The 4May18 options have priced a 3.8% post-announcement price change while the average change for the last eight quarters has been only 1.1% (about $2 when the stock is trading about $175).

Here are the trades we made this week using the Diagonal Condor Earnings Strategy that is outlined here in case you missed it earlier. Here are the spreads we will place just prior to May 2 (prices as they exist now):

Buy To Open MA 1Jun18 170 puts (MA180601P170)
Sell To Open MA 4May18 175 puts (MA180504P175) for a credit of $.25 (buying a diagonal)

Buy To Open MA 1Jun18 182.5 calls (MA180601C182.5)
Sell To Open MA 4May18 177.5 calls (MA180504C177.5) for a credit of $.17 (buying a diagonal)

After paying a commission of $2.50 per spread at the commission rate charged to Terry’s Tips subscribers at thinkorswim, each pair of spreads will incur a maintenance requirement of $500 less the $42 plus the $5 commission, making it an investment of $463 (the maximum theoretical loss).  One of the spreads is guaranteed to make a gain no matter what the stock might do after the announcement.

Here is the risk profile graph for the above spreads, assuming that implied volatility (IV) of the 1Jun18 option series will fall by 3, from 28 to 25 after the announcement.  This compares to the current IV of the 4May18 series which carries an IV of 35.

MA Risk Profile Graph April 2018

MA Risk Profile Graph April 2018

The break-even range for these positions goes from about $170 to $183.  If the price ends up at any price within this range, there should be a profit.  Historically, the stock has fluctuated by an average of about $2, which would place it between $173 and $177.

If the historical fluctuation continues, these positions could deliver 60% or more on investment for a single week of waiting it out.

If the stock fluctuates more than we expect (and finishes outside of the break-even range), we would roll over the expiring options before they expire on May 4 and sell new weekly out-of-the-money options for the 11May18 series, and continue doing so until we took in sufficient new premium to make the entire experience a profitable one.  We would have five weekly opportunities to accomplish this.  Of course, nothing is guaranteed, but weekly fluctuations tend to be much more moderate once the earnings week has passed, and that is the kind of market where this kind of diagonal or calendar spreads do their best.

If the stock fluctuates more than $2.50 from the $166.36 price when we placed the spreads, you might want to adjust the strike prices by $2.50 in the same direction.

Final note: MA has been a good underlying for Terry’s Tips.  In 2017, one of our actual portfolios traded MA options, and the portfolio gained 152% for the year. You can get a full (and free) report on how this worked out by requesting it below.

Facebook (FB) Play – Diagonal Condor Earnings Strategy

Wednesday, April 18th, 2018

Here is the link to the Seeking Alpha article on FB: https://seekingalpha.com/article/4164510-expect-facebook-earnings-announcement

This article explains our thinking behind the trades we suggested for the upcoming Facebook’s earnings announcement taking place next week.  See full recommendation below. 

Facebook (FB) announces earnings after the close on April 24, 2018.  I have submitted an article to Seeking Alpha outlining the reasons I believe that the stock will trade higher (or at least, not lower) after the announcement compared to its current level. If they accept my article for publication, I will send you the link.  If they don’t accept it in a timely basis, I will send it along to you.

Here are the trades we made this week in accordance with this positive post-announcement outlook using the Diagonal Condor Earnings Strategy that is outlined here in case you missed it earlier.  Note that one of the diagonals is being placed at a slight debit, a small deviation from the strategy.  This should not be a problem because the 1Jun18 options are considerably higher than this debit, and will surely hold up enough so that one of the two spreads is guaranteed to be a serious gainer.

BTO 1 FB 1Jun18 160 put (FB180601P160)
STO 1 FB 27Apr18 165 put (FB180427P165) for a credit of $.25 (buying a diagonal)

BTO 1 FB 1Jun18 177.5 call (FB180601C177.5)
STO 1 FB 27Apr18 172.5 call (FB180427C172.5) for a debit of $.28 (buying a diagonal)

IV of the 27Apr18 options is 47 compared to 31 for the 1Jun18 series (this huge difference is what makes this play so potentially profitable).

Here is the risk profile graph for these spreads assuming that IV for the 1Jun18 series will fall from 31 to 26 after the announcement.  I think there is a fair chance that it will not fall that far, and the results could be even better than what is indicated below:

Facebook Risk Profile Graph April 2018

Facebook Risk Profile Graph April 2018

These spreads require a maintenance requirement of just over $500 per pair of spreads.  One of them is guaranteed to make a gain no matter what the stock price does.

For the past 8 quarters, FB’s post-announcement fluctuation has averaged 3%.  This graph shows that a profit should result if the stock fluctuates less than $5 (about 3%) in either direction.  The potential gains are over 60% for a one-week play if the stock fluctuates less than $5 (and ends up at any price between $165 and $173).

If the stock fluctuates more than $2.50 from the $166.36 price when we placed the spreads, you might want to adjust the strike prices by $2.50 in the same direction.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

Diagonal Condor Earnings Strategy Update #3

Thursday, April 12th, 2018

This is our third suggestion on how to carry out the Diagonal Condor Earnings Strategy on companies which are about to announce earnings. The first two suggestions (RHT and KMX) resulted in 40% gains in a single week when the stock fluctuated only moderately after the announcement.  One of these times, the stock is likely to fluctuate more than we would like, and we will be able to put the second part of the strategy to work.  This will involve selling out-of-the-money weekly puts and calls over the next few weeks until the initial trade turns into a net gain.

This week’s choice is TDAmeritrade (AMTD) which announces before the market opens on Tuesday, April 24, 2018.  Implied volatility (IV) of the 27Apr18 options has not escalated at this point – it is 32.5, barely higher than a six-week-out 25May18 series (31).  We expect IV for the 27Apr18 series to move much higher over the next 10 days, and we hope to take advantage of higher option prices as well as a possibly higher stock price before the announcement date.

Here are the trades we made this week.  Note that the diagonals were set up at a small debit rather than the credit that we seek with this strategy, but when we roll over the 20Apr17 puts and calls to the next weekly series, we expect to create solid credits, especially if IV for those options moves higher as we expect.

BTO 1 AMTD 25May18 57 put (AMTD180525P57)
STO 1 AMTD 20Apr18 60 put (AMTD180420P60) for a debit of $.11  (buying a diagonal)

BTO 1 AMTD 25May18 64 call (AMTD180525C64)
STO 1 AMTD 20Apr18 61 call (AMTD18042061) for a debit of $.28  (buying a diagonal)

Once we roll over these options to the 27Apr17, we expect our net investment will be about $250 per set of spreads ($300 maintenance requirement less $50 net credit).  Here is the risk profile graph for those spreads after the roll has been made:

AMAT Risk Profile Graph April 2018

AMAT Risk Profile Graph April 2018

For the past 8 quarters, the post-announcement fluctuation has averaged 1.75%.  This graph shows that a profit should result if the stock fluctuates less than 5% in either direction.  The potential gains may not appear to be significant, but there seems to be a fair chance to make 20% on the investment for a single week of waiting.

LRCX Diagonal Condor Earnings Play

Thursday, April 5th, 2018

This is a possible option play using the Diagonal Condor Earnings Strategy that we recently sent you details about.

Lam Research (LRCX) announces earnings after the close on Tuesday, April 17, 2018. The stock has been on a downtrend for the past several weeks, a good indication that expectations are seriously lowered.  We have seen many instances when lowered expectations have resulted in a higher post-announcement date regardless of how well or poorly the actual results were compared to estimates. If you agree with this prognosis, you might consider making these trades (when the stock is trading about $196):

Buy To Open # LRCX 18May18 180 puts (LRCX180518P180)
Sell To Open # LRCX 20Apr18 195 puts (LRCX180420P195) for a credit of $2.20  (buying a diagonal)

Buy To Open # LRCX 18May18 220 calls (LRCX180518C220)
Sell Open # LRCX 20Apr18 205 calls (LRCX180420C205) for a debit of $.30  (buying a diagonal)

This is the risk profile graph for the options which expire on Friday, April 20, 2018 at a time when LRCX was trading about $196 and assuming the implied volatility of the May 25 options will fall from their current 43 to 38 after the earnings announcement on April 17th:

LRCX Risk Profile Earnings Graph April 2018

LRCX Risk Profile Earnings Graph April 2018

The two spreads will involve an investment of about $1400 per pair of spreads.  The maintenance requirement is $1500 and there is a net credit of about $100 after commissions.  If the stock were to end up at any price between $195 and $205, the graph shows that a gain of about 50% on investment would come our way.

The break-even range extends from about a 5% drop to an 8% rise.  This is well within the 4.9% average fluctuation that LRCX has made over the past 8 quarterly announcements.

Since there is a net credit from selling the two spreads, one of the spreads essentially is guaranteed to make a profit.  If the stock were to end up at any price between $195 and $205, both April 20 short options would expire worthless and the May 18 options would still have significant residual value.

If the stock were to fluctuate so much that it ended up outside the $195 – $205 range, the expiring April 20 options could be rolled over to out-of-the-money options in the April 27 series, likely at a credit.  There would be 5 additional weeks where short-term premium might be collected so that the original spreads might ultimately prove to be profitable even though it did not work out as expected in the announcement week.

As with all investments, you should only make option trades with money that you can truly afford to lose.

Happy trading,

Terry

 

A Carmax Spread Trade to Put the Diagonal Condor Earnings Strategy to Work

Tuesday, April 3rd, 2018

A Carmax Spread Trade to Put the Diagonal Condor Earnings Strategy to Work:

Carmax (KMX) announces earnings before the market opens on Wednesday, April 4, 2018.  If anyone would like to place the spread trade that we suggest below, the order must be placed no later than the market close on Tuesday, April 3rd.

Here are the numbers we compiled for KMX for the last eight quarters:

The prices in green are lower than the last pre-announcement price, suggesting that expectations are rising.  Most companies we tested show much many more green numbers than KNX.  Most of the time, KMX showed a high correlation between the actual results and what the stock price did after the announcement (while one might expect this would be universally true, our back-testing and personal experience has proved otherwise).  While the direction of the change for KMX was highly consistent (beating estimates resulted in a higher stock price, and vice versa), the magnitude of the change was not consistent.

In the June 2017 announcement, earnings were a whopping 23% above estimates, but the stock only gained 4% after they became public. In the next quarter, September 2017, earnings exceeded estimates by only 3% while the stock gained 10%.

KMX does not seem consistently beat or fall behind estimates.  This is a different pattern than we see in many companies who low-ball guidance, and then exceed estimates by a large amount quarter after quarter.  KMX does not seem to do this.

The average post-announcement stock price change for KMX was 4.9%.  This is less than the current option prices which have priced in a likely 5.7% change.  Someone who likes the stock might take advantage of the higher option prices and write an out-of-the-money call against their stock, and collect some nice premium in addition to some price appreciation if the stock manages to move higher.

We do not have a strong feeling concerning which way we feel the stock is headed after next week’s announcement other than that we think it will probably go in the same direction as the actual results compared to estimates. Since there is no clear pattern of how well the company does compared to estimates, this leaves us with a neutral position on the direction the stock might take after the announcement.

We have developed what we call the Diagonal Condor Earnings Strategy as our preferred options play prior to announcements.

Based on our neutral outlook on KMX, these are the spreads we placed for the upcoming announcement:

Buy to Open KMX 11May18 58 puts (KMX180511P58)
Sell to Open KMX 06Apr18 61 puts (KMX180406P61) for a credit of $.08  (buying a diagonal)

Buy to Open KMX 11May18 67 calls (KMX180511C67)
Sell to Open KMX 06Apr18 64 calls (KMX180406C64) for a credit of $.08 (buying a diagonal)

The net maintenance requirement (investment) on these spreads is $294 per pair ($300 – $16 plus $10 commission), and we have a net credit of $6 per pair in the account.

This is what the risk profile graph looks like after the market close on April 6, assuming that implied volatility (IV) of the May options falls by 3, from the current 33 to 30 (which is consistent with prior earnings week IV drops for 5-week-out options).

With KMX currently trading just below $62, the graph shows that we should end up with a gain if the stock ends up at any price between $59 and $67 on Friday, April 6th.  The sweet spot of the graph shows an approximate gain of $200 (about 66%) if the price ends up between $61 and $64.

If the stock fluctuates by its average post-announcement amount (4.9%), it would end up somewhere between about $59 and $65. In six of the last eight quarters, the fluctuation would have landed somewhere inside of this range, and in two of the quarters, it would not have.

To summarize our thinking, based on the level of IV for the options prior to the announcement (67) compared to IV for further-out options (33), investors do not get unduly excited about earnings announcements from KMX. The stock generally fluctuates after the announcement in the same direction as the results compared to estimates.  The company does not show a pattern of either consistently beating or falling behind estimates.  We believe this pattern is a perfect candidate for the options play outlined above which is essentially a neutral outlook, neither particularly bullish or bearish, but does best if the stock only fluctuates moderately after the announcement.

Diagonal Condor Earnings Strategy

Monday, March 26th, 2018

Summary of Strategy: Based on 17 years of studying price changes following an earnings announcement, Terry’s Tips has designed a strategy  which has a high probability of successfully navigating the extreme volatility that usually accompanies quarterly earnings reports.  The strategy is based on the observation that there is very little correlation between the actual numbers reported and what the stock does after the announcement.  Stock price fluctuations tend to be larger in announcement weeks and smaller in subsequent weeks.  That is just about all we can say about most earnings events, except that we have identified one indicator that appears an average of only once a year for most companies, and when this indicator is triggered, the stock has a much higher probability of going up than down.

The Diagonal Condor Earnings Strategy only applies to companies which have weekly options. Two diagonal spreads are bought, one with puts and one with calls.  The long side is in the furthest out weekly series (usually six weeks out) and the short side is the weekly series that expires just after the earnings announcement.  The long sides are well out of the money and the short sides are at strikes much nearer to the current stock price, and each spread is bought at a credit. Since the Implied Volatility (IV) of the short-term options is considerably higher than that of the longer-term options at earnings time, a credit can be established with a much smaller range between the strikes than is available when earnings is not a factor.

There is only one maintenance requirement for the two spreads because only one of the spreads can lose money, and the other one has a guaranteed profit of some sort.  The strike prices of the short options set up with a range of possible stock prices within which the investor hopes the stock ends up after the announcement.  If it does, both short-term options will expire worthless and the investor will bank both the original credit from the spreads and selling the residual long options. When this occurs, there is an immediate gain averaging between 30% and 50% of the initial net maintenance requirement.

As an alternative to cashing in the positions and taking a profit when there is a moderate stock price change after the announcement, near-the-money options could be sold in the next weekly series for additional premium to take advantage of the propensity of stock price fluctuations to be much smaller in the weeks following the earnings week fireworks.

The net effect of the Diagonal Condor Earnings Strategy is to use the higher option prices that exist during earnings week to inexpensively set up the 10K Strategy of calendar and diagonal spreads which is one of the foundation strategies of the Terry’s Tips program.  This strategy does best when the underlying stock does not fluctuate very much, and this is exactly what typically happens for most companies in the few weeks after quarterly earnings are announced.

If the stock fluctuates more than the investor wishes after the announcement, a potential short-term loss is likely, but there are still five remaining weekly series of options that could be sold against the long positions to recover the announcement-week loss.  The strike price of one of the long options (the one that the stock price moved away from) may be changed by buying a vertical spread so that the original maintenance requirement is not increased when slightly out-of-the-money options are sold against them in the next weekly series.  The in-the-money short-term option will be bought back and a slightly out-of-the-money option sold in the next weekly series.  The net changes at the end of expiration week should result in a net credit which will reduce the maximum possible loss (the original net maintenance requirement).

This strategy is designed to make a profit in the earnings week whenever the stock fluctuates by an amount which is about 20% less than the fluctuation baked into the earnings week options.  In those weeks when the fluctuation exceeds the number priced into the option prices, there will be up to five weeks for selling new premium to recover the losses caused by the excessive fluctuation.  Since these weeks will probably have only moderate weekly price changes, it should be possible to collect significant amounts of premium decay from the near-to-the-money short puts and calls each week.

A Look Back: About five years ago, we did a lot of work on a model which was designed to successfully predict the direction of a stock price change after an earnings announcement. The model was primarily based on the assumption that investor expectations played a greater role in how the stock moved after earnings than the actual results themselves. If expectations were too high, the stock would fall regardless of how good those results might be. We tried to get a handle on how high expectations were, based on several variables, including whisper numbers published by WhisperNumbers.com and how much the stock price rose or fell in the week or two before the announcement.

At one time, we successfully predicted the direction of the post-earnings change on 8 consecutive earnings plays (usually selling vertical credit spreads which we hoped would expire worthless), but then we ended up being wrong on a couple of consecutive ones, and we discontinued these plays. It became apparent that the whisper numbers we were dealing with were not particularly reliable. It was not clear how these numbers were compiled by WhisperNumbers.com. Of course, they said it was a proprietary algorithm, but they admitted to polling selected analysts while inviting the public to cast votes on their website. The composite estimates of analysts is supposed to be what defines expectations, so we wonder about these analysts who were asked to reveal their “true” estimates. If their opinions were indeed different, why wouldn’t they be telling their clients what they really believed rather than favoring a private company with their innermost thoughts. And asking individual investors what they were expecting, if they actually counted those votes, should be a contrary variable instead, since individual investors are notoriously wrong most of the time. Bottom line, we did not have confidence in those whisper numbers.

Now we want to try again, with a couple of changes. Instead of relying on whisper numbers, we will check what the stock price does in the days leading up to the announcement as an indication of the level of expectations, and also look at the historical record of earnings announcements for each company to see if we can identify any consistent patterns. We may also take a look at recent hedge fund or insider trading activity if there is any significant action that might help predict the direction of the post-announcement price change.

Equally important, we will use a different options strategy than we applied in the past. This time around, we will use diagonal spreads which we sell at a credit (or extremely low debit in some instances). The short side will be in the weekly series that expires on the Friday after the announcement, and the long side will be in the longest-out weekly series (usually six weeks later). We will place both a put and call credit spread, usually in the afternoon of the day before earnings are released. One of the two spreads will be guaranteed to make a profit (both the initial credit and whatever the residual five-week-out out-of-the-money option can be sold for).

The other spread may also be profitable, depending on the strikes that were selected. In the event that the stock moved so much that one of the spreads loses more money than the gaining spread makes, causing the combination of spreads not to be profitable at the end of expiration week, there will be about 5 more weeks that new premium (weeklys) might be sold against the remaining long option, hopefully enough so that a loss will be avoided.

If both spreads are successful, the entire play can begin and end in a single week. If the combination of spreads is not profitable, we will have to spend up to five weeks trying to recover from the too-high post-announcement stock price change by collecting new premium each week. If the strategy works out to be profitable in a single week over half the time (which I believe should be the case), and we can roll out of the others over five weeks or less, it certainly should be a profitable concept.

Case Study – Red Hat (RHT):  Let’s use Red Hat (RHT) as an example. They announced earnings after the close, on Monday, March 26, 2018. We were uncertain about the expectation level, so we gave ourselves a little wiggle room in both directions and sold both 3/30/18 puts and calls which were slightly out of the money. In the afternoon of March 26 when RHT was trading about $153, we made the following trades:

BTO # RHT 04May18 141 puts (RHT180504P141)
STO # RHT 29Mar18 148 puts (RHT180329P148) for a credit of $.11 (buying a diagonal)

BTO # RHT 04May18 162.5 calls (RHT180504C162.5)
STO # RHT 29Mar18 155 calls (RHT180329C155) for a credit of $.13 (buying a diagonal)

If the stock ended up on Thursday (markets would be closed on Good Friday) anywhere between $148 and $155, both these spreads would end up being profitable (both from the credit collected plus the value of selling the residual May 4 options). If either of the short options expired in the money, we would need to buy it back and close out all the positions if a profit could be made, or roll over the in-the-money option to the next week and collect some additional premium in an effort to eventually make a gain over the next five weeks.

The stock ended up at $149.51 which placed it between the 148 and 155 range of our short options, so both of them were about to expire worthless (and were bought back for $.05, with no commissions payable at thinkorswim).  For half our contracts, we sold the long side of these spreads for a total of $3.48.  This yielded a net profit of $357 (including the original credit) per pair of spreads after all commissions on our net maintenance requirement of $781, making it a gain of 46% for the week.  Not bad, but hopefully a whole lot less than we will eventually do on the contracts that we did not sell.

We did not close out our remaining contracts because we wanted to experiment with rolling short options to the next weekly series to take advantage of the expected quiet period for RHT after earnings week.

Near the close on Thursday we bought back both the soon-to-expire puts and calls for $.05 and sold 06Apr18 148 puts for $2.52 and 13Apr18 155 calls for $1.55.  This gave us a net credit if $387 per pair of original spreads and reduced our investment (net maintenance requirement) from $781 to $394.

Here is the risk profile graph for these positions per pair of spreads for the week ending April 6, 2018:

RHT Risk Profile Earnings April 2018

RHT Risk Profile Earnings April 2018

If RHT remains quiet as we expect, we might earn about $200 on our net investment of $394, or almost 40% in one week. Our break-even range for the week extends from a drop of $4 on the downside to a little more than $5 on the upside.  We will update this case study as the weeks go by going forward.

 

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