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Posts Tagged ‘RHT’

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.

 

Red Hat (RHT) is Set To Extend the Momentum

Monday, January 22nd, 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 portfolios to spot outperforming stocks and place spreads that take advantage of the momentum. We selected this same company six weeks ago, and the spread we placed at that time will have gained 60% by next Friday if the stock ends up above $123 at that time (it is about $126 right now).

Terry

Red Hat (RHT) is Set To Extend the Momentum

Red hat stock saw some strong gains in 2017 and several analysts believe there is further upside ahead including BMO Capital Markets who have raised their targets to $142.00 and Wells Fargo & Co who are looking for a rise to $144.00.

From a technical perspective, RHT has been consolidating sideways for a few months.  A confluence of support from a rising trendline dating back to a low posted in June and a horizontal level at $120.00 recently triggered a turn higher which has resulted in the stock price climbing back above its 50-period daily moving average.  The $130 handle may present a hurdle but a break of the level is likely to accompany a renewal of upside momentum.

 

RHT Chart January 2018

RHT Chart January 2018

*source Tradingview.com

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

Buy To Open RHT 16Feb18 120 Puts (RHT180216P120)
Sell To Open RHT 16Feb18 125 Puts (RHT180216P125) for a credit of $1.83 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when RHT was trading near $126.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

If you use our favorite broker for this trade, tastyworks, your commission on this trade will only be $1 per opening contract ($2 per spread) (and there is no commission on closing trades, only the $.10 clearing fee).  Each contract would then yield $181 and your broker would charge a $500 maintenance fee, making your investment $319 ($500 – $181).  If RHT closes at any price above $125 on February 16, both options would expire worthless, and your return on the spread would be 57% (647% annualized).

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

IBD Underlying Updates January 18, 2018

IBD Underlying Updates January 18, 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

Red Hat (RHT) Dips Following Earnings, Is it A Buy?

Tuesday, December 26th, 2017

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 portfolios to spot outperforming stocks and place spreads that take advantage of the momentum.

We wish you the best of the holiday season…

Terry

Red Hat (RHT) Dips Following Earnings, Is it A Buy?

Red Hat stock pulled back in the past week after crushing third-quarter earnings targets.  Several analysts revised up their price targets both ahead and after the earnings report.  Here are two of them – Red Hat (RHT) PT Raised to $145 at Barclays, Sees a Strong Q3 Report Ahead and Red Hat (RHT) PT Raised to $150 at Deuthsche Bank on 3Q Beat & Raised FY Guidance.

RHT has seen a strong rally throughout the year and last week’s pullback has not altered the positive technical outlook.  A rising trendline dating back to a low posted in August remains intact and held the stock higher in the past week.  Horizontal support at the psychological $120.00 handle was found near the trendline line to add confluence.  In the absence of a bearish catalyst, the technicals suggests the stock can continue its uptrend from here.

RHT Chart December 2017

RHT Chart December 2017

*source Tradingview.com

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

Buy To Open RHT 19 Jan 18 $122 Puts (RHT180119P122)
Sell To Open RHT 19 Jan 18 $123 Puts (RHT180119P123) for a credit of $0.50 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when RHT was trading near $123.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

If you use our favorite broker for this trade, tastyworks, your commission on this trade will only be $1 per opening contract ($2 per spread) (and there is no commission on closing trades, only the $.10 clearing fee).  Each contract would then yield $48 and your broker would charge a $100 maintenance fee, making your investment $52 ($100 – $48).  If RHT closes at any price above $123 on January 19, 2018, both options would expire worthless, and your return on the spread would be 92% (1053% annualized).

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

IBD Underlying Updates December 21, 2017

IBD Underlying Updates December 21, 2017

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

Earnings Growth To Fuel Further Momentum For Red Hat (RHT)

Monday, October 2nd, 2017

This week we are featuring a recent addition to the Investor’s Business Daily (IBD) Top 50 List of companies.  We use this list in one of our portfolios to spot outperforming stocks and place spreads which will profit if the upward momentum continues.  Actually, the stock can even fall a little for the maximum gain to be realized on these spreads.

The 10 Terry’s Tips option portfolios enjoyed another stellar week last week, gaining an average of 1.2%, and making the ytd number a whopping 78% for all the portfolios combined.  This is over 7 times as great as the 2017 results for the market (SPY) which is up about 11%.

Terry

Earnings Growth To Fuel Further Momentum For Red Hat (RHT)

Red Hat reported above-consensus earnings in the past week and several analysts have refreshed their upside targets since.  Here are two of them – Red Hat PT raised to $128 at BMO Capital and Red Hat PT Raised to $117 at JPMorgan Following 2Q.

Red Hat’s earnings report triggered a push higher above a notable horizontal level at $108.04 that held the stock price lower on several attempts throughout the month prior to the report.  RHT also regained the 20-period daily moving average on the back of the same surge and hit fresh 52-week highs.  The horizontal level and the moving average fall in close proximity to each other, offering a strong confluence of downside support.

 

RHT Chart October 2017

RHT Chart October 2017

*source Tradingview.com

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

Buy To Open RHT 17Nov17 105 Puts (RHT171117P105)
Sell To Open RHT 17Nov17 110 Puts (RHT171117P110) for a credit of $1.45 (selling a vertical)

This price was $0.02 less than the mid-point of the option spread when RHT was trading near $111.  Unless the stock rallies quickly from here, you should be able to get close to this amount.

If you use our favorite broker for this trade, tastyworks, your commission on this trade will only be $1 per opening contract ($2 per spread) (and there is no commission on closing trades, only the $.10 clearing fee).  Each contract would then yield $143 and your broker would charge a $500 maintenance fee, making your investment $357 ($500 – $143).  If RHT closes at any price above $110 on November 17, 2017, both options would expire worthless, and your return on the spread would be 40% (325% annualized).

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

IBD Underlying Updates September 28, 2017

IBD Underlying Updates September 28, 2017

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

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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.

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