Trading Options during Earnings Season

In this post I will look at one basic, yet a very effective, strategy on trading options during earnings season.

Options are not for the weak hearted! You only deserve the gains if you can take the losses. By no means am I an options prodigy. But sometimes, the simplest of strategies can result in ridiculously phenomenal gains.

I'll take you back to summer 2008 earnings season when financials were battered.

It was Monday, July 14, 2008, before the opening bell. Options were expiring on the coming Friday. A major downtrend was in play and call option premiums were cheaper than candy. Analyst expectations from financials were extremely pessimistic. Major financial institutions including WFC, MER, GS, JPM, MS, and BAC were lined up to release earnings. WFC was set to release earnings first.

Much to everyone’s delight, WFC releases better than expected earnings. There was a ray of hope. A belief of survival that things are not as bad as it seems. The result, WFC moved higher and its peers followed.

Options traders had plenty of time to make their move. All they had to do was understand a simple concept:

Often, a particular firm-specific event propels the company’s price and moves the whole industry/sector with it.

WFC’s better than expected earnings release was that event which propelled the financial sector higher. I remember the Ask price on 1 OTM GS Call was about $.30. The premium on this call did not budge higher for 1-2 hours after WFC’s earnings release. In the next 2-3 days, the $.30-$.50 was more than $11. So, if you had invested $150 (ignoring commission), then the $150 would be $3,300-$5,500. There was one case where the return would be $11,000 with an investment of about $1,000.

Although these results are not as spectacular as GOOG, they are spectacular nonetheless. Anyone can achieve these results if they don’t sell prematurely.

The process is quite simple but should require proper due diligence.

1) Identify the sectors and the industry you want to trade. Ideally you would want to find overbought or oversold sectors because volatility is greater in overextended markets.

2) Determine when options expire.

a. I prefer trading those industries who report earnings towards the end of the month
because option premiums are much lower.
b. Sometimes if there is a big run-up before earnings release. In this case, option
premiums are much expensive and are possibly already overbought.
c. When there is a big run-up before earnings release, the earnings surprise and
guidance has the surpass analyst expectations by a larger margin for the after-move
to be significant.
d. More often than not, you will observe light trading volume before a company releases
earnings.

3) Identify the order in which major companies of the selected industries that are set to release earnings.

4) If the first company that releases earnings surpasses analyst expectations and offers favorable guidance, then buy moderately out of the money calls on the company’s industry peers. If the company’s prospects are gloomy, then buy puts on it’s industry peers.

Don't forget to visit my website at http://www.technicalanalysisbase.com/ and my other blog at http://technicalanalysisbase.blogspot.com/

Sanjeet Parab_____________________________

What makes stocks move? - Know your sectors!

Intro
In this post, I’ll cover how understanding sector strength can ease your security selection process and improve your trading returns. Furthermore, I’ll briefly touch on how a trader can use sector seasonality to devise trading strategies.

What makes stocks move?

According to Teeka Tiwari, more than 68% of what makes a stock go higher is sector-related. I would not question his observation because it is similar to Michael Parness' insights on 'Laggards.'

What is a laggard? When a stock's movement lags its industry/sector peers, the stock is considered a laggard. Such a price divergence frequently corrects itself when the lagging stock catches up with its peers.

The point is that a trader needs to be aware of sector strength. As I covered in my ‘Tradable Universe’ post, the greater the number of open positions, the more difficult it is to manage them. By determining the sectors you want to focus on, you narrow your tradable universe.


Know your Sectors!

Below are ticker symbols of key sector indices.

XNG: Natural Gas
RXH: Healthcare Prov
XCI: Computer Tech
RXP: Healthcare Prod
MSH: High-Tech
IIX: Internet
BTK: Biotech
XAU: Gold & Silver
UTY: Utilities
CMR: Consumer
DRG: Pharmaceutical
XTC: Telecom
BKX: Banking
XBD: Broker/Dealer
CYC: Cyclical
RMZ: Real Estate
SOX: Semiconductor
DJT: Transports
XOI: Oil

CLICK HERE TO VIEW COMPONENTS OF THESE SECTOR INDICES

Strategy:

Once you pick the sector you want to focus on, you can then determine the particular sector index component you wish to trade. If you rely on screening techniques for security selection, then MSN’s Deluxe Investment Finder is one of the best screening tools available.


AMEX Sector SPDRs

XLY: Consumer Discretionary SPDR
XLP: Consumer Staples SPDR
XLE: Energy SPDR
XLF: Financials SPDR
XLV: Health Care SPDR
XLI: Industrials SPDR
XLB: Materials SPDR
XLK: Technology SPDR
XLU: Utilities SPDR

Strategy:

Rather than analyzing individual stocks (sector index components), you may directly trade SPDRs. However, if you prefer trading individual stocks rather than ETFs, then you can select individual components of the ETF(s) of your choice just like I mentioned above.


Sector Seasonality

Sector seasonality has similar implications as sector/asset class rotation. Very simply put, at different times of the year, certain sectors are favored over the others because they are statistically more likely to give you greater returns. Sector seasonality was featured first in 1968. A Merrill Lynch study showed that buying seven sectors around September/October and selling in the first few months of 1954-1964 tripled the gains of holding them for those 10 years.

TO VIEW THE UPDATED SECTOR SEASONALITY CALENDAR, CLICK HERE.

Strategy:

The strategy should be fairly self explanatory.

1) Look at which sector is expected to be strong according to the Sector Seasonality Calendar.
2) Either select the Sector SPDR or sector components.
3) Buy long/Sell short depending on your expectations of sector strength.


Don't forget to visit my website at http://www.technicalanalysisbase.com/ and my other blog at http://technicalanalysisbase.blogspot.com/

Sanjeet Parab
_______________________________