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The first quarter of the year is in the books, and we've entered a new earnings season.
Hundreds of companies, including Facebook Inc. (Nasdaq: FB), Amazon.com Inc. (Nasdaq: AMZN), Netflix Inc. (Nasdaq: NFLX), and Alphabet Inc. (Nasdaq: GOOGL), are releasing their earnings reports this month.
And the fact of the matter is… earnings drive the markets.
This means that there are some immediate actions you'll need to take in order to seize big profits – and prevent even bigger losses.
Now there are some trading and financial experts out there who say that earnings season is overrated.
But I strongly disagree… especially when it comes to options traders like you and me.
Earnings Season Is the Most Profitable Time of the Year
With second-quarter earnings season underway, traders and investors alike are waiting for hundreds of companies to release their earnings reports.
And as we discussed last month, a company's earnings report is extremely important because it tells you how well the company did in the quarter and how the future of the company looks in ensuing quarters.
Investors pretty much take one of two paths when it comes to earnings season:
- Increase the size of their holdings within these companies, or
- Reduce the size of their account positions on a positive or negative report.
If the earnings reports line up with, or beat, earnings expectations… and if the future outlook of a company is favorable, investors will likely up their stakes in that company within their overall portfolios.
On the other hand, if the report is subpar, or if it's good but the company's future outlook is weaker than expected, investors may sell their entire positions or lighten up on their holdings by selling a percentage of their company stakes to reduce the cost basis.
But traders – and especially options traders – do not have that luxury…
Unlike investors who take the buy-and-hold approach, traders are, for the most part, looking for an immediate pop or drop in the stock price before, during, and after earnings. The hope is that they will be "on the right side of the trade" and will see a substantial return as a result of earnings.
If you've ever owned a call option on a company as a result of its earnings report, I'm sure you have stories about trades that showed phenomenal rates of return and others that showed a return of zero.
While this may sound counterintuitive (as I like to trade short-term options), my view is that trading should not be a thrill-seeking venture. The reason? If your emotions are riding a roller coaster of excitement, happiness, and sadness, you will get burned out and could end up deciding to stay away from options altogether.
And this would eliminate one of the easiest, most viable sources of generating extra income…
The good thing is, there's an easy way to prevent that from happening to you. And it boils down to having a plan of action for entering and exiting your trades and knowing the prospects of what your stock can do before you spend your first dime.
As I mentioned earlier (and as you've probably heard yourself), there's a sentiment some trading "experts" hold near and dear that earnings season is completely overhyped. Among others, the belief is that you cannot predict what will happen to a stock based on earnings.
While it's true that no one can predict what will happen, you can trade with the expectation of a possible stock move based on what the company has done in the past and how it's expected to do in the future. And this information all lies within its earnings report.
You can go to the company's website and look up all of the upcoming earnings release dates and if earnings will be released before or after the market opens. And this process is very easy because there are Internet sites that solely specialize in earnings. These sites will gather everything earnings-related about companies and post the earnings expectations, earnings release date, historical earnings, and if the earnings will be announced before the market opens or after the market closes. Pre- or post-market earnings releases are extremely important, but we will talk about why later.
Below is an image that shows "wizards," which are scans that search for the companies that consistently underperform or outperform their earnings expectations:
As you can see, there are a handful of stocks that have a history of consistently beating earnings expectations, such as Expedia Inc. (Nasdaq: EXPE), Alphabet Inc. (Nasdaq: GOOGL), Citrix Systems Inc. (Nasdaq: CTXS), Southwest Airlines Co. (NYSE: LUV), and O'Reilly Automotive Inc. (Nasdaq: ORLY). I want to point out two in particular, EXPE and CTXS, which have a history of popping up by 10% after their earnings announcements. I'm only pointing these out to give you an idea of the information you can find… these are NOT trade recommendations.
The objective is to find stocks like these with this repeating pattern and trade around earnings so that you can pinpoint your optimal trade exits and entries.
After you run your search, you'll want to pay attention to a few things in particular:
- The number of earnings periods analyzed
- The estimated number of days until the next earnings report
- The actual number of times a stock has met or bested earnings expectations
- The actual number of times a stock has missed earnings expectations
Earnings and the Options Trader
As an options trader, you'll want to analyze how a stock has done in past earnings reports when you're trading around earnings.
Consider a put option if you see that a company has a history of missing its earnings expectations or has a history of forecasting low earnings numbers in future quarters.
Consider a call option if you see that a company has consistently beat its earnings expectations and has a history of forecasting high earnings numbers in future quarters.
With that said…
Always keep in mind that the information you gather about a company's earnings may offer you some confidence about a stock ticking upward or downward, but there's still only about a 50/50 chance that it will actually move in your favor.
There's a particular trading strategy you'll need to use in order to successfully trade options on a stock during earnings season…
But we won't talk about that until later, so stay tuned…
Double Your Money by Market Close with These Price Patterns: Thanks to March's upbeat jobs report, there's an increasing level of consumer confidence regarding the economy. And that means we could be looking at some great trading opportunities with triple-digit profit potential right now…
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.