Option trading can result in profitable trades around earnings, and it’s not as risky as you might think.
Some option trading strategies are complicated, but a basic strategy using call options can actually help minimize risk around earnings.
Option Trading Caps Downside Risk
Here’s how it 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 is when 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.
Netflix Call Option Too Pricey?
Let’s look at a recent call option for Netflix. The streaming video service’s stock has been getting support at the 10-week moving average for the first time after a breakout from a base in early January.
When shares were trading around 309, a slightly out-of-the-money weekly call option with a 310 strike price (April 20 expiration) came with a premium of around $15.40, offering a trade with elevated downside risk of 5%.
Analyst commentary about Netflix has been positive ahead of Monday’s report after the close. Quarterly profit is expected to jump 60% from the year-ago period to 64 cents a share. Sales are seen rising 40% to $3.69 billion.
Meanwhile, a call-option trade for Atlassian was equally pricey. When shares exchanged hands around 59.90, a monthly call option with a 60 strike price (April 20 expiration) had a premium of $3.15. This offered a trade with lofty downside risk of 5.3%. Results are due Wednesday after the close.
Alcoa Shows Relative Strength
Aluminum producer Alcoa also boasts a healthy chart. Results are due Wednesday after the close. When shares were trading around 54.50, a weekly call option with a 55 strike price (April 20 expiration) came with a premium of around $1.70. This presented a trade with reasonable downside risk of 3.1% ($1.70/54.50). Alcoa is working on a cup-shaped base with a 57.60 entry, although it’s rallied sharply the past two weeks, making the base a bit lopsided.
In the latest week, JPMorgan (JPM) was still below the 50-day moving average ahead of Friday’s earnings report. The latest pullback was relatively tame, but recent signs of institutional selling in the stock made it a risky call-option trade.
Still, when shares were trading around 113.25, a weekly call option with a 114 strike price had a premium of around $1.65, offering a trade with limited downside risk of 1.5%. Keep in mind that cheap premiums are sometimes cheap for a reason. Wall Street wasn’t expecting JPMorgan to move much on earnings, although shares were up 1.5% to 115 in early trading Friday.
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