Call options could make sense for several top stocks set to report earnings in the coming week.
Many option strategies can be complicated and risky. But a basic strategy using call options — or put options — can actually help mitigate risk around earnings.
Lockheed Martin’s chart is forming a flat base with a 363.10 buy point. Intel, Amazon and Microsoft also have bullish charts, making all five reasonable candidates for call option trades. Keep in mind it’s been a mixed environment for earnings breakouts lately. Superior results have resulted in several gaps up in price, while just good results have often seen selling pressure.
Call Options Cap Downside Earnings Risk
Here’s how the call option strategy works: First, look for top-rated stocks near buy points — stocks you truly want to own — just before earnings.
Target weekly call options with a strike price just out of the money and close to the proper buy point of the stock itself. Out-of-the-money means the strike price is above the underlying stock price. In some cases, you can use an in-the-money strike price. Just make sure the premium isn’t too pricey.
To calculate the maximum risk, divide the cost of the option premium by the current stock price. Then multiply by 100. Look for a range of 2% to 4%.
The strategy lets you capitalize on a bullish earnings report. Risk is limited to the cost of the option. If the stock gaps down on earnings, the loss is limited to the amount paid for the contract.
One call option contract gives you the right, but not the obligation, to buy 100 shares of a stock at a specific price (the strike price). You pay an option premium for this right. Every contract comes with an expiration date.
Put options can be used for weak performers with bearish charts. The only difference is that an out-of-the-money strike price is just below the underlying stock price. One put option contract gives you the right, but not the obligation, to sell 100 shares of a stock at a specific price. Profits are made when the stock falls below the strike price.
Lockheed Martin Sets Up
Let’s look at a recent call option for Lockheed Martin. Results are due Tuesday before the open.
When shares recently traded around 351.25, a weekly call option with a 352.50 strike price (April 27 expiration) came with a premium of around $5. This presented a trade with low downside risk of 1.4% ($5/351.25).
Keep in mind that Lockheed is not a fast mover, the main reason behind the cheap premium. When taking the premium paid into account, Lockheed would have to rally past 357.50 for the trade to start making money.
Earnings from group peer Flir Systems (FLIR) will be out Wednesday before the open. It was still in buy range after a low-volume breakout over a 51.80 cup-with-handle buy point. Northrop Grumman (NOC) also reports Wednesday before the open.
Several other high-quality names near buy points are set to report in the coming week, including TD Ameritrade (AMTD) (Monday after the close); ServiceNow (NOW), Varian Medical (VAR), Visa (V) (Wednesday after the close) and Arch Coal (ARCH), Domino’s Pizza (DPZ), Fiat Chrysler (FCAU), Shutterstock (SSTK) and Union Pacific (UNP) (Thursday before the open).
Netflix Pays Off
When shares were trading around 308.50, a weekly call option with a 310 strike price (April 20 expiration) came with a premium of $13.70. This presented a trade with downside risk of 4.4% ($13.70/308.50). Netflix gapped up after delivering another strong quarter. Shares closed Thursday at 332.70.
After a breakout nearly straight off the bottom, aluminum producer Alcoa (AA) was near the top of the 5% buy zone from a 57.60 buy point. It reported strong earnings late Wednesday.
When shares traded around 59.40 just ahead of earnings, a weekly call option with a 59.50 strike price (April 20 expiration) came with premium of $1.70. This offered a trade with attractive downside risk of 2.9% ($1.70/59.40). Alcoa hit a high of 62.35 Thursday before backing off.
Meanwhile, after a nice bounce off the 10-week moving average, Atlassian (TEAM) was extended ahead of its Thursday earnings report. That made it a no-go for a call option trade. The other problem? When shares were trading around 62.25, the first available out-of-the-money strike price was 65. Taking the premium into account for the May contract (around $2.25), Atlassian would’ve had to rally past 67.25 for the trade to start making money.
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