Date Published: 2017-06-07
Written by Ophir Gottlieb
Look, this could feel a little uncomfortable, not in that it's complex, it's actually quite easy and fun, but it is the difference between professional traders and non-professionals. And it's just not easy to read how a simple information gap can be the difference between the top 0.1% and everyone else, sometimes. Here we go.
There is a way to trade Applied Optoelectronics Inc (NASDAQ:AAOI) options right after earnings that has been a winner without a loss for an entire year, and further has returned over 170% annualized returns in that time frame.
The Trade After Earnings
Selling a put spread in a stock that is rising, in hindsight, obviously looks like a great idea. Here is the stock price chart for Applied Optoelectronics Inc over the last two-years:
We can see the stock that is ripping, but we have also labeled the earnings announcements with the blue "E" icon, and noted the two poor earnings results in yellow. Remember those two circled dates.
If we had blindly sold an out-of-the-money put spread every month in Applied Optoelectronics over the last three-years, the results were actually not very impressive.
We can see 30.2% return, while taking on a lot of risk. The next logical step is to try this same approach but simply avoid (skip) earnings days. Here are those results:
We can see a nice improvement, going from a 30% return up to 43.8% and taking a lot less risk.
But there's more going on here. It's a fair question to ask if trading every month is worth it -- is it profitable -- is it worth the risk? There's an action plan that measures this exactly, and the results are simply stunning.
Let's test this idea:
In English, let's see what would have happened if we sold this same put spread, but rather than trading every month, we simply traded the month right after earnings.
More explicitly, the rules are:
* Open short put spread 2-days after earnings.
* Close short put spread 29-days later.
* Use the option that is closest to but greater than 30-days away from expiration.
And here are the results of implementing this much finer strategy:
All of a sudden, by removing the risk of earnings, and then removing the risk of 2 out of the other 3 months every quarter, we find option returns that have spiked to 82.4%. But of course, we can't just test an idea because it works -- there must be logic to what we're doing.
And yes, there is sound logic to this approach to option trading.
Our idea here is that after earnings are reported, and after the stock does all of its gymnastics, up or down, that two-days following the earnings move and for the next month, the stock is then in a quiet period.
If it gapped down -- that gap is over. If it beat earnings, the downside move is already likely muted.
If you recall that stock chart from the top, there were a couple of times that Applied Optoelectronics missed on earnings and fell hard. Here is a zoomed in image of the earnings reported on 5-9-2016:
The stock gapped down hard, losing more than 17% in a single day -- this was a bad earnings release. But here's where our logic comes into play. If we're right, after two days of price movement, the stock should find a sort of equilibrium, and stop dancing around.
It's not a bet that the stock will rise -- it's an investment in the idea that the stock "won't go down very much" in just the month after earnings, and after the initial stock reaction to earnings.
We can see this exact phenomenon. The earnings date was May 9th, the trade entry date was 2-days later, May 11th. From that entry point to one month later when the trade closes, the stock rose.
Yep, even after a terrible earnings release, once the bad news had its chance to play out, the stock was fine. And since a short put spread is simply a bet that the stock "won't go down a lot," this set-up has played perfectly.
Here is how the strategy has done over the two-years:
We see a 56.8% return over eight earnings cycles. But remember, since this trade is only live for one-month a quarter, that 56.8% return was actually just 8-months of trading, not two-years.
Here's what we see over the last year:
Now we see a 46.4% return over the last four earnings cycles, but the beauty of this approach has not just been superior returns, it doesn't tie up capital for months that aren't profitable. Since this was just four-months of trading, that's over 170% annualized returns.
To see how to do this for any stock and for any strategy with just the click of a few buttons, we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work
Thanks for reading.
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
The author has no position in Applied Optoelectronics Inc (NASDAQ:AAOI) as of this writing.