The More You Know

 | Jul 25, 2014 | 10:00 AM EDT
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I went through a slew of charts Thursday and discussed how to use them for potential option trades into earnings, along with some post-earnings trade possibilities. But there is another use for these charts. What about those traders holding a long or short position prior to earnings? Often there is the worry about what to do around earnings. Do I ignore it and just keep my position? Do I close the position and look to buy back later? Do I hedge the position? If I hedge, what approaches should I consider? If you want answers to these questions, and I think you do, you should keep reading.

Enough of infomercial babble. As I said, earnings are the great unknown of trading, so the best you can do is gather as much information as possible to make a decision that matches your risk tolerance and goals. For this exercise, I'm going to assume I was long each of these stocks into earnings. The list includes Amazon (AMZN), LogMeIn (LOGM), Baidu (BIDU), Pandora (P) and Starbucks (SBUX). The fact their earnings are out has no bearing on what the decision would have been. In some cases, the results may be correct and others wrong.

First up is Amazon. In the past, this was a slam-dunk hold, but after two quarters of poor performance, one look at this chart would signal paying up for a hedge with the understanding that if the stock went down, I would still lose some money (the cost of the hedge) but I would know my risk. The big move up in October 2013 would be enough for me to want to stay involved. I might also consider some sort of 10% out-of-the-money call sale or ratio call spread against my long position.

LogMeIn was hit hard recently and I could see someone having doubts about holding it into earnings. But when you look at the past four results, why would you hesitate holding into earnings? As usual, I could understand hedging at least a portion of shares, but until this trend changes, I can't imagine a trader wanting to step to the side after four strong closes in a row.

Although Baidu is not as exciting as LOGM, I wouldn't hesitate holding it into earnings. I would likely try to augment upside with a ratio call spread since the last three results were green but small. Otherwise, the only hedge I would consider would be a disaster-type hedge with a cheap put far out of the money. It has been consistent four quarters in a row. Again, why fight the trend?

Pandora is at the other end of the spectrum. How can I justify holding this into earnings? Four straight red closes and the stock only opened higher the day after earnings once. Again -- say it with me -- why fight the trend? This is a name I would completely hedge, move to some calls or just move to the sidelines.

Last is Starbucks. This is another one with four green closes the day after earnings. Even though the stock has advanced, I would have a hard time not doing something here given the last three reports barely saw the stock in the green. A rather tight collar comes to mind, or a long put paired with a ratio call trade with the willingness to risk the put premium on the downside. The July 2013 result is the only reason to consider the ratio call spread, but beyond that, it would just be a simple collar of long shares.

In the end, looking at history can be beneficial not just for outlining speculative trades into earnings but also for determining how to handle an existing position into earnings. Nothing is perfect, but as the saying goes, "The more you know."

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