I see it every time earnings season rolls around, and it always bums me out: Millions of investors try to pick the right stock to buy at the right time for the right price, hoping maybe the company they've picked beats earnings estimates this time.
If they're right, they can pocket 7%, 10%, 15% in profits. If they're wrong, oh well - there's always next quarter.
It might sound like investing, but it's not all that different from rolling the dice or betting the ponies. Going through earnings season like that is a gamble - one that no one needs to make. It's even riskier during a global pandemic when companies are either crushing it or barely getting by.
You don't need to leave money on the table, though, or sit earnings out. You don't have to risk for the chance to pocket a little.
The smarter, safer, and just plain more profitable way to speculate on corporate earnings is to trade them. That way, you're in and out, counting your gains before the report hits the Street.
You don't necessarily need management to hit a home run; the stock doesn't need to skyrocket - it just needs to move.
And you don't have to take my word for it, either. I'm going to show you how this works with a company I suspect just put a very solid quarter on the books: PayPal Holdings Corp. (NASDAQ: PYPL).
This trade has a great risk/reward ratio, and you can put it on today, right now. In fact, the sooner the better...
This Popular Payment Processor Should Beat Again
Even as a buy-and-hold proposition, I love PayPal. It was spun off by online auction kingpin eBay Inc. (NASDAQ: EBAY) back in 2015 and is now available in even more places where online shopping gets done.
With that said, I should take a second to mention I'm not just picking PayPal from a random list of stocks. Fact is, PayPal shows up in my proprietary Money Calendar tool as one of the best pre-earnings performers - and the stock and its options have all the right characteristics I'm looking for. (You can learn how to get some of my best options trading research like this right here.)
Nevertheless, PayPal is one of the winners of the COVID-19 pandemic and the national coin shortage that came along with it.
PayPal has a big portfolio of "contactless" payment products, particularly Venmo, so as more and more routine shopping moved online, and what in-person shopping there was became "touchless," the bottom line became fatter and fatter.
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It's beaten earnings-per-share (EPS) estimates for eight of the past nine quarters. Its Q2 earnings were great - it beat those EPS estimates by $0.46 to come in at $1.07 a share, and revenue was up 22% from Q2 2019.
Now, the country is opened up to a large degree, but I think the main ingredients that have boosted PayPal's earnings are still in play, so its Q3 report - which hits after the market closes on Monday, Nov. 2 - should be another big hit.
So we've got a recipe for a stock that's probably going to power higher in the long run, and importantly, will have a lot of options activity in the run up to Nov. 2.
Now, how to cash in?
Why So Many Investors Get It Wrong
Well, here's the thing: Sure, a company that consistently beats earnings estimates will very likely go up in the long term, but it can be really tricky to predict near- and medium-term future prices just from earnings announcements.
For one thing, you've got the whole "buy the rumor, sell the news" thing, where a stock gets bid up ahead of earnings only to drop when investors take profits once those earnings are reported.
On the other hand, you could have a disappointing earnings call where management introduces some cost-cutting or profit-boosting measure that looks good for next earnings season, which can send the stock up - sell the rumor, buy the news.
It's a real roll of the dice, like I said, and you don't have to take the chance.
The Smart Way to Play PayPal's Q3 Earnings
As we've talked about once or twice before, you can play the implied volatility (IV) in PYPL options. IV is really a measure of the angst or worry options traders feel at any one time.
That's directly reflected in the premium you pay or collect for an option; it can make an option "expensive."
This move is really playing to that anxiety. We'll be buying PYPL calls, we'll watch them quickly get even more expensive, then sell them back to the market just ahead of earnings when they're at their priciest. Options are a much safer, cheaper way to speculate, and you don't have to hang out until after the report.
That's the big mistake that investors who gamble on a stock going higher at earnings make; they sell too late.
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Because, as you'll see on this chart, these options rise far and fast, but they fall just as quickly. Timing is critical here.
Take a look at this screen grab, right from my laptop here:
The candlesticks show PYPL shares moving up ahead of quarterly earnings. The big, thick jagged red line, though, is implied volatility.
You can see the IV - PYPL options' premium - building quickly because of the "will they/won't they" uncertainty that's baked into every run up to an earnings report. It builds to a big spike, then falls off dramatically as the reports are public and certainty returns.
So if you're trading like this, you definitely want to live on the left-hand side of those spikes. If you're caught on that right-hand, downward side, you could fall victim to a volatility crush, but if you sell your calls before earnings, that shouldn't happen.
As you can see on the screencap up there, PayPal tends to go up before earnings, and its call options do, too.
The best option to go with here is the PYPL Nov. 6, 2020 $202.50 call.
The strike is just outside the money (OTM), and you can sell this option back before the company reports after the market closes on Nov. 2. You could even sell it on the afternoon of Nov. 2, if you wanted to wait that long, but unwind the position when you feel like you've made enough money.
At $8.07 per contract, or $807 per option, it's a little more expensive than I'd usually go for, but you've got to bear in mind that the profit potential is theoretically unlimited on this one, so the risk/reward ratio is just right.
Now, before you go, imagine doing this week after week...
You see, this trade could be a winner in just a few days. It's part of some research I've been doing on something I call the "Four-Day Profit Cycle" - an extremely short-term pattern that's outperformed the S&P 500 by nearly 17% in the first eight months of 2020.
It's true: Playing this cycle correctly could potentially double your money in under 100 hours. Click to learn how...
About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.