Now that the first half is over, now we can get down to some serious business! EARNINGS!
I love this time of year. This is where we separate the wheat from the chaff and find out just who did well last quarter. Mind you it was a challenging one for most businesses – a soft patch in the economy, problems in Greece and other Euro countries, effects from the Japan earthquake and an implosion in commodity prices – not to mention crude rising to nearly $115 a barrel. Can also throw in continued weakness in housing, construction and job creation into the mix for a tough environment. However, we’ve heard some good things at least verbally from CEO’s and some recent economic improvement and there could be upside surprises.
I play trends and patterns. The best trends are the ones which offer the best opportunity to profit from option trading. The best patterns are ones that repeat over and over, finding the most reliable ones which put the highest probability play in our midst. Trading is not about being perfect, rather setting ourselves up for the best scenario. They don’t always work out but more often than not they do.
So, what kinds of trends and patterns do I play during earnings season? We often find charts and technicals tell the story before the earnings – sort of an ‘I told you so’ pattern. Is there good volume in the days and weeks leading up to earnings? Are there good trends in the technical indicators? Are we overbought? Oversold? Do you believe those patterns continue as I do? Good earnings are not often a ‘one off ‘ event, meaning they trend for several quarters. If you find a company reporting a good quarter then the next couple are likely to be to strong, too. Two examples of this are Red Robin (RRGB) and Herbalife (HLF). For RRGB, they reported a big upside surprise in Q4 2010 and repeated the process in Q1 2011. HLF has had a few quarters of big beats, the company at/near alltime highs – so no surprise. The patterns of good and bad quarter trends seem to work both ways, too. Downside ? Look no further than Google, which has seen some really bad stock performance leading up and following disappointing earnings news.
There is one caution to playing earnings – if you expect a binary result be prepared for it. In other words, a big win or a major or total loss. I frequently warn of this possibility and it happens each time. Don’t put all your eggs in one basket, rather use discretionary risk capital on these plays. That way you can weather any adverse moves. So, what if a stock goes against you? It happens, part of the game but it’s not an error or mistake. The only ‘mistake’ you can make is not sizing properly with respect to your account and risk management. Keep yourself in the game.
