Trading Options Around Earnings Reports
The Dynamic Wealth Report
April 7, 2008
Open Season . . . Big Bucks From Earnings
A few years back I was hunting in Montana with a good group of guys.
Honestly, I’m not much of a hunter. But I enjoy being outdoors in very
beautiful places. I also like the camaraderie one finds with a group of
men all on a common mission.
What I remember most were the stories and tips that everyone shared.
Sitting around a warm fire on a cold night everyone seems to have
something to contribute. This is where the knowledge from generations of
hunters gets passed along.
I’m about to go hunting today . . . but not for deer. Today I am hunting
profits.
Earnings season officially starts today. Alcoa (AA) announces earnings
this afternoon. They’re always the first to report and I’m sure they’ll
do so in grand style. For the next few weeks, the financial world will
be focused on a steady stream of news and numbers.
Another event is happening right now as well. Like a pack of wolves,
options traders everywhere are starting to salivate.
This time of year – earnings season – is when really big profits can be
made in options. If you know what you’re doing.
So in the spirit of hunters everywhere, gather round the fire. I’m going
to share with you a few important tips and tricks. These ideas are all
focused on trading options during earnings season. One of these might
help you capture that big buck! (pun intended)
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The Importance of Volatility
This may seem a little backwards, but trust me. The more volatile the
markets, the better it is for your option trades. The market over the
last few months has been extremely volatile, which makes this earnings
season all the more lucrative.
Now, I know what you’re thinking. Why do we like volatility? We like
volatility because it causes big moves in stocks. When you buy an
option, you want the biggest move possible, in the shortest amount of
time. These big moves help amplify your profits.
Think of it this way. If GE makes an important announcement, the stock
might move (up or down) $3, $4 or even $5. If Google makes an important
announcement the stock might move up or down $30 or $40 or $50 points! I
bet you can guess which set of options I’d rather own. So secret number
one is look for stocks with lots of volatility.
The Importance of Estimates
The importance of understanding Wall Street earnings estimates is
overlooked by many new option traders. Every company reporting (at least
those worth paying attention to) has an earnings estimate. This number
is one of the most important numbers to know. If a company beats their
estimates the stock could rally. If they miss . . . watch out below. Either way, understanding that number is very important.
Except . . .
The only thing that can be more important than earnings numbers is
management comments about the future. Earnings are strange. You might
get a company who beats their earnings estimate and the stock falls. You
might see the exact opposite where a company misses estimates but the
stock rallies. What causes this? Management comments about the future.
Let me give you an example.
Commodities have been trending upward for the last few years, but they
recently pulled back. Investors are starting to wonder if this pullback
is the end of the run or just a breather on a climb to higher levels. Earnings are less important for companies tied closely to the commodity
sector. Everyone is going to focus on management comments about the
future. Secret number two is to know the earnings estimates. . . and
when to ignore them.
I’m cheating on this last secret.
I actually gave this away some time ago and a lot of people made money
from it. So here it is again. Pay very close attention to earnings
announcements of other companies in the industry. Sounds simple but lots
of investors overlook the obvious.
A few months ago, I noticed solar stocks were jumping higher on earnings
announcements. I knew that if one or two companies had really strong
earnings the others probably did as well. Sure enough the first few
announced big quarters and record backlogs. Everyone in the industry was
doing really well . . . and those who were watching closely made great
money trading the options.
One last thought. If you’re trading options based on earnings
announcements pay very close attention to your positions. This is not
the time to turn a short term trade into a long term investment. Watch
the stock and have a trading plan. Know why you are buying something and
always have an exit. If a trade moves against you for whatever reason,
get out. Preserve your capital and look to trade something else. Wishing
and praying that a trade turns around once the announcement has been
made usually doesn’t work in your favor.
I sincerely hope these tips and tricks help you capture that big buck.
Happy hunting!
• Mortgage Finance (Up 21%)
The Mortgage Finance industry has seen a remarkable turnaround in the last
month. In the last 30 days the entire industry is up more than 20%.
Fannie Mae (FNM) and Freddie Mac (FRE) seem to be showing signs of life. Investors are clearly focusing on the positive impacts of the Federal
Reserve actions.
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