Stock Market Strategies: Using Options Around Earnings Helps … – Investor's Business Daily

BREAKING: Market Rally Isn’t Finished, But Growth Giants Lag

When it comes to making money in the stock market, a common pitfall for new and experienced investors alike is to buy a stock just ahead of its earnings report because it’s “acting right.” Fundamentals are top-notch, there’s a compelling growth story, and the stock is in a bullish chart setup.
Sometimes, the strategy works. Other times, it can end badly, especially if the stock gaps down on disappointing earnings.
Earnings reports have slowed to a crawl as the year winds down, but Wall Street will be watching results from Cal-Maine Foods (CALM) in the coming week. Results are due Wednesday after the close.

The egg producer has been rallying in heavy volume ahead of the results even as selling pressure builds in the major stock indexes. But after six straight up sessions through Thursday, CALM stock could use a breather despite the fact it’s still toying with a breakout over a conventional entry of 62.74.
For the current quarter, the Zacks consensus estimate calls for adjusted profit of $4.30 a share, up sharply from 2 cents in the year-ago quarter. Zacks doesn’t have a revenue estimate for CALM, but the FactSet consensus is for revenue growth to accelerate for the sixth quarter in a row, rising 104% to $797.8 million.
The first week of January is light on earnings as well, although keep an eye out for earnings from top performers like Conagra Brands (CAG) and Lamb Weston (LW).
For the week of Jan. 9, Q4 earnings kicks into gear with financial stocks like Bank of America (BAC), Citigroup (C,) JPMorgan Chase (JPM) and Wells Fargo (WFC) set to report.
A basic options trading strategy around earnings — using call options — allows you to buy a stock at a predetermined price without taking a lot of risk. Here’s how the options trading strategy works and what a call option trade recently looked like for Cal-Maine Foods.
First, identify top-rated stocks with a bullish chart. Some might be setting up in sound early-stage bases. Others might have already broken out and are getting support at their 10-week moving average for the first time. And a few might be trading tightly near highs and refusing to give up much ground in the stock market. Avoid extended stocks in the stock market that are too far past proper entry points.
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In options trading, a call option is a bullish bet on a stock. Put options are bearish bets. One call option contract gives the holder the right to buy 100 shares of a stock at a specified price, known as the strike price.
Put options are for weak performers with bearish charts. The only difference is that an out-of-the-money strike price is just below the underlying stock price. A put option gives the holder the right to sell 100 shares of a stock at a specified price.
You earn profits when the stock falls below the strike price with a put option.
Once you’ve identified an earnings setup for a call option, check strike prices with your online trading platform, or at cboe.com. Make sure the option is liquid, with a relatively tight spread between the bid and ask.
Look for a strike price just above the underlying stock price (out of the money) and check the premium. Ideally, the premium should not exceed 4% of the underlying stock price at the time. In some cases, an in-the-money strike price is OK as long as the premium isn’t too expensive.
Choose an expiration date that fits your risk objective but keep in mind that time is money in the options market. Near-term expiration dates will have cheaper premiums than those further out. Buying time in the options market comes at a higher cost.
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This options trading strategy lets you capitalize on a bullish earnings report without taking too much risk. Risk is equal to the cost of the option. If the stock gaps down on earnings, the most you can lose is the amount paid for the contract.
Here’s what a recent call option trade looked like for Cal-Maine Foods, a liquid name in the options market.
When CALM stock traded around 62.35, a slightly out-of-the-money monthly call option with a 62.50 strike price (Jan. 20 expiration) came with a premium of around $2.75 a share per contract, or 4.4% of the underlying stock price at the time. That’s a little above the 4% threshold but not too bad considering there’s some time for the option to work.
One contract gave the holder the right to buy 100 shares of CALM stock at 62.50 a share. The most that could be lost was $275 — the amount paid for the 100-share contract.
When taking the premium paid into account, CALM would have to rally past 65.25 for the trade to start making money (62.50 strike price plus $2.75 premium per contract).
For traders anticipating a “sell the news” scenario, a bearish put option for CALM using the same strike price and expiration offered a slightly lower premium of around $2.45. But it was a much less liquid option with very low open interest.
Follow Ken Shreve on Twitter @IBD_KShreve for more stock market analysis and insight.
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Notice: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. Authors may own the stocks they discuss. The information and content are subject to change without notice.
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