Posted in Strategy
By: Tom Gentile on December 20th, 2020 • 3 mins read
Successful traders are consistent, reliable and follow the rules. These individuals also take time to learn historical patterns. One of the best and most dependable way to select winning stocks is by looking at corporate earnings reports. Every publicly traded company reports quarterly earnings. These earnings reports include sales, revenues, earnings, growth rates and forecasts. Quarterly earnings announcements often set an up or down stock gap into motion.
Stocks that gap upon these announcements, generally have a history of doing so. The following option strategy relies on the occurrence of these gaps.
Straddling Earnings Volatility and Win Big
Gaps that occur when earnings are announced are easy to find. A discerning trader can identify stocks that consistently gap up or down when earnings are reported and can “straddle the fence” via an option trade that will create profit, whether the stock gaps up or down.
Celsius Holdings (NASD: CELH) is a good example of a company that’s stock generally gaps upon earnings. In fact, as of November 2020 this stock had gapped at the four previous earnings announcements. These gaps accounted for an average of 84.55% return on investment (ROI).
Though it was clear that a gap would take place on November 2, 2020, the direction of the gap was unknown. I do not advise trying to predict the direction of a gap. By buying a Call AND a Put, traders can profit regardless of the gap’s direction. A Call generates profits when the stock gaps up, and a Put generates profits when the stock gaps down.
When the stock moves enough, one of the options makes more than the other loses. This is referred to as a “straddle.” If on November 2, 2020, you purchased December 18, 2020 CELH $20 Call for $3.25 and a CELH $20 Put for $2.80, the total cost of the straddle would have been $6.05 x 100 shares controlled and a debt of $605. The bulk of the risk in a straddle is the cost, making the maximum risk for this trade $605. The following graph illustrates this straddle.
This risk graph shows that an upward or downward gap would have both generated unlimited profits. On 11/12/20, CELH announced earnings and gapped up big, providing a $668 profit/110.4% ROI!
The CELH Dec 18, 2020 $20 Calls shot up from $3.25 to $12.45 and the CELH Dec 18, 2020 $20 Put dropped to $0.30. We cashed in!
Here is how I determine which stocks to straddle. This data was generated by one of my scanners.
History is always your best guide. These stats show that CELH’s average ROI over the past four earnings periods was 84.55%, with 100% winners when entering 10 calendar days before earnings were announced.
The current state of the market, coupled with the pressure of Covid-19, could create an earnings season laden with gaps. The current climate is ideal for a strategy such as this, that capitalizes on volatility.
Here are some other setups of companies that had 100%-win rates over four consecutive earnings periods.
A straddle approach is very calculated and must be entered into on the number of days indicated under the “Calendar Days Before Earnings” column. The earnings date under the “Next Earnings Date” column must also be verified. Sites like “earningswhispers.com” indicate if earnings are confirmed. If the confirmation date and date shown in the data above are different, simply change your entry date so that you enter the number of “Calendar Days Before Earnings” specified.
Once you employ this strategy, just hold on for the ride and exit on the specified (or newly determined) exit date.