Wall Street's devised dozens of options strategies, but one stands above the rest when it comes to trading earnings.
Money Morning's options trading specialist, Tom Gentile, just showed his subscribers how to use a "straddle," which can be the best options strategy for earnings trades. Plus, we'll show you which stock he's watching this earnings season (more on that in just a bit).
Last year, we saw solid gains fueled by the promise of strong earnings, higher employment, and an overall more robust economy. Massive tax reform and rollbacks of regulations were supposed to kick-start the economy after years of steady, but still anemic, growth.
So far, earnings have not had the positive income on the stock market like most expected. For example, several big banks beat their earnings estimates for the recent quarter, jumped up in price, but closed significantly lower on the day.
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How can you position yourself to profit when it seems that earnings may or may not push stock prices higher?
That's where the straddle comes in.
A straddle is an excellent options strategy to use during volatile markets. That's exactly what we've seen in 2018, with the CBOE Volatility Index up 62% year to date.
A straddle involves buying both an at-the-money (ATM) call and an ATM put with the same strike price and the same expiration. An option that's "at the money" simply means that the stock price and the option's strike price are the same or very close.
When you buy a call and the stock moves significantly higher, your call makes money. Your put will expire worthless.
The opposite happens if the stock drops significantly. Your put makes money, while your call expires worthless.
The beauty is that if the underlying stock makes a big move in either direction, the profit you make on the winning option far outweighs the loss you'll take on the other. Consider the losing option to be insurance on your trade.
Why is it called a straddle? Because you are figuratively straddling the fence, not knowing which way the underlying stock will move. But as long as it does move, you make money.
The best part of a straddle is that it does not matter which way it moves. All that matters is that it does move.
Now that you know how this options strategy works, here's a stock that Tom is watching extremely closely this earnings season…