Momentum stock traders face the same dilemma four times a year:
Hold winning stocks through earnings season OR close positions ahead of quarterly earnings reports.
Selling a winning stock to lock in gains ahead of a company’s earnings report is obviously the safest bet.
However, holding through earnings reports is often necessary to “catch the gaps” and yield big winners — think 50% to 100% or more.
Ideally, you need an earnings trading strategy that gives you the best of both worlds; you need options.
Continue reading to find out about a simple options strategy that limits your risk and allows for unlimited gains around earnings season.
Profit Buffers Matter
The current amount of unrealized gain is one key factor that should determine if you hold a winning stock through earnings.
If you are already sitting on a bullish stock with a 30 to 50% gain from your entry point, the decision to hold through earnings isn’t that tough.
But what if you’re stalking a stock that is ready to break out, but it’s scheduled to report earnings within the next few weeks?
It’s a challenging dilemma.
Building a position in the stock before its obvious breakout point is tricky because there is no guarantee the stock will gap higher after earnings.
And if the stock remains in its base, you could be stuck with a position that has little to no profit buffer heading into its earnings report.
On the other hand, you can miss out on massive post-earnings gaps if you wait for the stock to report earnings before buying it.
Any way you cut it, trading around earnings season is always a bit of a gamble.
But there’s an easy option strategy you can use that is ideal for this type of situation.
Here’s how it works…
Simple Options Strategy For Earnings
At Morpheus Trading, we need a 10% minimum profit buffer to hold an individual stock through its earnings report (20% is even better).
This being the case, how can we build a position in a stock that is scheduled to report earnings in a few weeks, while keeping risk in line?
The answer is to buy “near the money” call options that are one to six months out (depending on expectations).
These near the money call options are reasonably priced because we buy most breakout trade setups within the base — before the stock actually breaks out of its range.
If we buy a call for $2 to $3, there are no surprises; we know exactly how much we are risking heading into an earnings report.
To show you how it works, let’s walk through an option trade we recently discussed in The Wagner Daily and real-time trading room on April 19 and 20.
PayPal Pays Off
In late April, PayPal ($PYPL) was consolidating in a tight and narrow range above support of its rising 50-day moving average (just 5% below its all-time high).
Tight price action on declining volume within the range was a bullish sign, so we knew the move into the 50-day moving average (April 17 to 21) could be bought.
But with earnings in the way on April 26, we would be forced to sell $PYPL if it failed to move higher right away — remember the 10% minimum profit buffer requirement.
This is where the easy option strategy comes into play.
Rather than buying PayPal stock, we mentioned the idea of buying a $45 call option with July 21, 2017 expiration.
The call option was trading around $1.50 when we first alerted subscribers in the Realtime Trading Room on April 19 (it was also highlighted in the April 20 newsletter).
With the $45 call, we knew our maximum risk of holding through earnings was limited to the $1.50 paid for the $PYPL call.
Take a look at what happened next:
As you can see, PayPal broke out above its base and followed-through just a few days before its April 26 earnings release.
Then, fueled by a 9% positive earnings surprise, the stock gapped up and zoomed sharply higher over the next six weeks.
$PYPL stock rallied from around $45 to $55 — roughly a 22% gain.
The $45 call option responded by rocketing from $1.50 to a peak of more than $10 on June 9.
It has since pulled back to the $7.50 area, but the call option is still up 400% since our April 19 trade alert.
Subscribers still holding the winning option contract can maximize profits by trailing a stop below the recent “swing low” support.
However, be aware of time decay as the July 21 expiration date approaches.
A 400% gain on a call option is obviously sweet — but even better is that our risk was limited to just $1.50 per contract, even if PayPal would have cliff dived after earnings.
To be clear, we do not use options with every stock trade; we still swing trade individual stocks, just as we have done since 2002.
Nevertheless, quarterly earnings season provides the perfect opportunity to “up your game” with a simple and effective options trading strategy.
Subscribe now to The Wagner Daily and be instantly alerted to our best option trades in earnings season (and much more).