Why I Don't Trade Fear Ahead of Earnings

 | May 12, 2013 | 10:30 AM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

lnkd

,

wfm

,

rack

,

ibm

When you trade options, one of your main fears tends to be an event that triggers a move against you. A five-contract trade, opened at $2, can be vaporized in a day on some bad news. $1,000 can be nearly wiped out. It's not easy to recover from that, either. I've been there many times, and it stings. At the same time, if we use good risk management and control, these events will inflict only minimal damage.

You may ask: "Bob, why even go there at all? The market is open all other days aside from when earnings are released, so why go through the agony of a binary event?" These are good questions to ask, but let's break this process down a bit in order to glean a better understanding.

As always, let's start with the charts. In order to find my trade setups, I use the technical patterns that have historically worked for me -- these formations are often what show me where stock acceleration, momentum and trends are starting to develop. If earnings happens to merge with a ripe chart pattern, then so be it. The result might even constitute a catalyst to drive more buyers into a stock.

Have you ever wondered why a stock might perform well even after it misses on estimates or provides poor guidance? How about the ones that beat on earnings and get hammered mercilessly the following day? It can make you scratch your head in amazement, can't it?

Well, I have personally had some of my best trade results after an earnings release. In February we were long LinkedIn (LNKD) calls into earnings and the stock exploded afterward, and the same happened in Whole Foods (WFM) this week. Rackspace (RACK) likewise ran up into earnings -- but, in that case, the patterns became bearish post-earnings, which primed the stock well for a two way trade (strangle). That worked out very nicely for us.

The technicals reveal certain patterns that arise again and again -- but should we just avoid playing stocks or options around earnings? Most companies release their quarterly activity four times a year, so why would you panic each time? Yes, options pricing obviously is skewed toward the high side around earnings in the short term, especially in high-beta names that could move heavily. But, after these events stocks tend to simmer down, or we at least see a decline in implied volatility.

Did you see the action and reaction of IBM (IBM) before and after earnings? The shares had a big run-up into the report and a huge drop just after, returning right back to where it had been before the announcement.

So play the game the way you see fit. Don't let news, events and reactions influence your decision-making process. In the long term you're probably be proven right -- just sit tight.

Columnist Conversations

There were nice reversal-type candles on the weekly charts of the major indices. The DOW and the S&P forme...
A number of stocks on my watch lists are attempting to form positive candles a key support levels. I noted th...
Lang:
While last week was a day to pull the plug and contemplate where the market was headed, I waited for some conf...
Shares of TSLA have formed multiple hammer candles at a key level of support defined by: the September head an...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.