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HomeTrading NewsOptions Arena: Earnings

Options Arena: Earnings

We’ve been talking about earnings a good deal in these pages lately…

And today, I want to keep the conversation going!

By now, you know how our resident expert Chad Shoop feels about the seasonal event — after all, he’s designed a whole strategy around it.

But let’s see what the rest of our team thinks…

Are earnings an overhyped waste of time — or an overlooked gold mine?

The stakes are high today: As of last week, Amber’s win streak is still uncontested. According to Chris Cimorelli, it’s a bona fide battle of the sexes now…

(Click here to view larger image.)

Read on, and cast your vote for this week’s winner at the end!

Chad: The Earnings Report You NEED to Watch This Week

Earnings season is my favorite time of the year. That shouldn’t come as a surprise, because I talk about it all the time. Unlike other traders, though, I don’t gamble on the event itself. I jump in after the earnings announcement is released.

By jumping in after earnings, we let the market signal where the stock is headed next. And we only do this on a few stocks that have a great win rate (at least 75%).

I want to give you one stock to keep an eye on this week, to see if we get an Earnings Boost signal.

It’s NetApp (NTAP), a cloud software provider.

The stock is set to report earnings this Wednesday, and it has a very simple signal. If the company beats analyst expectations by at least 5%, and the stock jumps 5% or more, we want to buy calls on NTAP.

Again, we don’t trade before earnings. We wait until Thursday, check the post-earnings performance, and see if it’s enough to trigger a new trade.

If those two parameters are hit, we jump in.

Why? Because this stock has a 90% tendency to head higher after such an event. And in the options market, that move can turn into quick triple-digit profits.

So watch NetApp when the market opens on Thursday. If the stock is up at least 5%, and the company beats analyst expectations by 5% or more, jump in with calls.

This is just one of many stocks I’ll be watching this week and next.

Mike: Even Insider Trading Isn’t Enough to Profit on Earnings

Earnings announcements move markets. But the direction can be unpredictable.

Last week, for example, NVIDIA Corporation (NVDA) reported better-than-expected earnings and also topped expectations for revenue. Management gave an optimistic outlook for this quarter and analysts will need to increase their estimates to reflect that news.

Given all that good news, it’s reasonable to ask why the stock dropped 8%. Analysts speculated that the company has exposure to crypto markets and reduced demand for crypto will hurt NVDA. There are no signs that demand for crypto is softening, but NVDA’s market cap still declined about $45 billion.

That same day, Cheesecake Factory (CAKE) reported lower-than-expected earnings. And yet the stock was higher after management said the company was printing new menus with higher prices.

The SEC even found a case where hackers were charged with insider trading. These individuals accessed earnings announcements days before they were publicly released… and still only profited on about 77% of their trades.

There’s really no simple way to trade earnings. It could be best to wait for the announcement and then see how the market reacts. The potential for this strategy seems to have first been identified in a paper published in 1968.

And you might’ve heard that, in recent years, Chad found a way to reliably profit from such a strategy.

Amber: A Game of Shifting Expectations

In the first half of an earnings quarter, analysts speak to management teams to come up with estimates. As we move closer to the reports, analysts revise their earnings forecasts. Generally, they revise estimates downward after these discussions.

In sports terms, if this was a hurdle race, they would be lowering the bar. At the beginning of the quarter, the bar is about waist high. By the end of the quarter, the bar is just above the ankles.

Let’s take the current quarter for example. Analysts were expecting the companies in the S&P 500 to report earnings growth of 21.2% — well below the 31% growth of the previous quarter, because management told analysts that level of growth was unsustainable.

In the second half of the earnings game, companies report earnings. On average, about 76% of companies reporting in a quarter beat expectations. The average beat is 8.6%. The stock often jumps on the better-than-expected results.

We’re currently in the midst of a fairly typical earnings season. With about 84% of the companies in the S&P 500 reporting, 77% beat expectations. The average beat was 8.5%. And now analysts expect earnings growth of 30.9%.

But we can’t be sure a stock will jump on an earnings beat. Management may make negative comments on the earnings call. Or analysts may notice that costs grew faster than sales, or inventories were building up in the quarter.

There are many reasons a stock could beat earnings expectations and still fall. Which is one of the reasons I focus mostly on short-term trades. That way, I can limit exposure to the unpredictable earnings game.

Chris: All Artificial, But There’s a Clever Way to Play It

Earnings season is the closest thing you can find to a live sporting event in the stock market.

This isn’t necessarily a bad thing. Stocks are a marketplace. For a market to function, it needs buyers. And to attract buyers, you need advertising. And the best advertising has a bit of spectacle.

It’s a necessary evil, in my opinion.

I personally don’t give a rat’s hoot about earnings season because I know it’s artificial. Most earnings are cooked. EBITDA (earnings before interest, taxes, debt, and amortization) is a legal deception, a clever way to make a company’s financial health look better than it might actually be. Under EBITDA, it’s up to management’s discretion to include certain line items and exclude others.

It doesn’t take a brain surgeon to spot the conflict of interest there. Earnings season is like watching televised wrestling with Vince McMahon and pretending it’s the real thing.

I prefer to avoid it. The last time I made an earnings bet, the options market taught me a valuable lesson.

I bought calls on Tesla that were super pumped up from all the volatility before the announcement. Even though earnings were better than expected and the stock went up, my calls plummeted as volatility went through the floor — a war story I share in my new video with Chad.

That’s why I think Chad’s Earnings Boost strategy is clever. Always have. It’s like sneaking in when no one’s looking and running away with the bag. More investors should try it. So far, it’s the only sensible way to play earnings I’ve seen.

Just remember the earnings you see in the headlines are non-GAAP, which stands for “generally accepted accounting principles.” In other words, whack-ass accounting. And people wonder why some call the stock market a scam!

That’ll wrap up this week’s Options Arena… But the most important part is up to you.

Be sure to vote alongside your fellow readers in our poll below, and decide which of our True Options Masters should come out on top!

Mike Merson
Managing Editor, True Options Masters

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