Next week is the biggest week of the results season. More than a third of the members of the S&P 500 report results, including the biggest companies like Apple.
This blog post will focus on options strategies that can help equity investors during earnings season. This can be a time of high volatility and dramatic price movements, which options traders can potentially use to their advantage. We will consider two bullish trades for investors who expect recoveries and two methods of hedging for investors more concerned about falling prices.
|Tesla (TSLA)||$ 714 billion||4/26 pm|
|Alphabet (GOOGL)||$ 1.5 trillion||4/27 pm|
|Microsoft (MSFT)||$ 2 trillion||4/27 pm|
|Visa (V)||$ 486 billion||4/27 pm|
|Apple (AAPL)||$ 2.2 trillion||4/28 pm|
|Facebook (FB)||$ 857 billion||4/28 pm|
|Mastercard (MA)||380 billion dollars||4/29 a.m.|
|Comcast (CMCSA)||$ 250 billion||4/29 a.m.|
|Amazon.com (AMZN)||$ 1.7 trillion||4/29 pm|
|Exxon Mobil (XOM)||$ 237 billion||4/30 h|
- Vertical Call Spread: A bullish options strategy that can profit from a rally.
- Put credit spread: a neutral / bullish options strategy that benefits from a stock that does not fall.
- Vertical Sell Spread: A bearish options strategy that can profit from a downside.
- Covered call: a neutral options strategy that can help manage risk.
What are vertical call spreads?
Calls are options that set the level at which investors can buy a stock or an exchange-traded fund (ETF). They usually gain value when prices rise, but can also expire worthless
Options traders looking to profit from a rally can simply buy calls. They can also use a vertical spread to reduce some of their price risk.
A vertical call spread is when you buy one call near the money and buy another one further away from the money to generate credit. This lowers the overall cost and potentially increases their leverage.
Take the example of Tesla (TSLA). The electric carmaker’s 730 April 30 calls cost around $ 28.90, so an investor would have to pay $ 2,890 for a single contract. The electric car maker must close above $ 730 on Friday or they will expire worthless. They will break even at $ 758.90.
Alternatively, a trader could buy the 730 and sell an equal number of 740 calls on April 30. Like that:
- Buy 1,730 April 30 for $ 28.90.
- Sell 1,740 call April 30 for $ 24.30.
- Net cost: $ 4.60
This approach reduces their cost by 84%, thus reducing their potential loss if TSLA drops. It also reduces their breakeven point to $ 735. The maximum profit is $ 5.40, or 117%, if the prices close at $ 740 or more.
While the downside of the vertical spread is that profits are capped at the highest strike.
What is a put credit spread?
Puts are the opposite of calls because they set the price at which a stock or ETF can be sold. They gain in value when stocks go down.
However, investors can sell puts to earn income. They agree to buy a stock at a certain price at a certain time, in exchange for immediate payment.
Selling individual puts is very risky as there can be a significant downside risk. For example, a trader selling the TSLA 710 put on April 30 would earn $ 28.60. They will have to buy stocks for $ 710 if they fall below that price, regardless of their level. This means that they have potential losses up to $ 0.
A put credit spread is a bullish / neutral options trading strategy that manages some of this risk. It can be formed like this:
- Sell the 1710 April 30 for $ 28.60.
- Buy 1,700 put on April 30 for $ 24.50.
- Net credit: $ 4.10.
This approach reduces their potential reward, but also their risk. They will keep the $ 4.10 credit as a profit if TSLA closes above $ 710 upon expiration. If it falls below this line, the position will have a negative value of $ 10. But including the $ 4.10 collected now, they would only lose $ 5.90.
The put credit spread can help collect premiums and profit from declining time. Investors may want to consider it when they have an optimistic view of a stock, but don’t want to pay any money up front now.
What is vertical diffusion?
A vertical sell spread is the opposite of the put credit spread. It is a bearish strategy which takes advantage of a fall in price. Traders may want to use it to cover a long position in a stock or to speculate on a downside.
For example on Facebook (FB):
- Put 1290 April 30 put for $ 5.90
- Sale of 1,280 April 30, bid for $ 2.90
- Net cost: $ 3
Like vertical call spread, vertical put spread can benefit from directional movement. This potential options trade on FB would gain $ 7, or over 200%, if FB drops 5.6% to $ 280 by next Friday. The breakeven point is $ 287 and it will expire worthless if the social media giant stays above $ 290.
What is a covered call?
Covered calls can be another useful option strategy during earnings season. This involves selling calls on a stock you already own.
- Hold (or buy) 100 FB shares (currently at $ 296.52).
- Sale of 1310 calls on April 30 for $ 4.30
- Remember: 1 call contract equals 100 common shares.
The trader will keep the $ 4.30 per share ($ 4,300 in total). This reduces its cost base in FB.
If the stock stays below $ 310 by the end of next week, they’ll hold onto their stock and the $ 4.30 credit. This can help cushion a potential drop.
If the stock rises above $ 310, they will be forced to sell their shares at that price. They will earn money but their earnings will be capped.
Covered calls have a few potential advantages:
- Investors are making money now, offering protection against falling prices.
- Investors can profit from the decay of time, which occurs near expiration – especially after a major event like earnings.
- Covered calls do not require a rally to earn money. This makes them similar to credit spreads.
In conclusion, options are an increasingly important part of investing and managing risk. They can be adapted to suit many circumstances and needs. Hope this article helps you understand some potential uses for this results season.