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The One-Week Pre-earnings Momentum Trade in Baidu

Baidu Inc (NASDAQ:BIDU) : The One-Week Pre-earnings Momentum Trade With Options

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Baidu Inc (NASDAQ:BIDU), also referred to as the Google of China, has been on a historic momentum run of late, seeing all-time highs as the company delves deeper into artificial intelligence and broadens its business away from just search. Here is a two-year stock chart to put the recent optimism into perspective:

We can see a few things, here:

(1) The stock price has found a parabolic move higher which can only be described as massively bullish momentum.
(2) The stock move after the last earnings announcement was abruptly higher.
(3) The stock price is wildly above the 50- and 200-day moving averages, denoted as the red and blue lines, respectively, which could indicate an overbought situation.

So, we do find ourselves with a stock this very pricey and has already found a huge momentum pop.

Now we look forward, and there is a bullish momentum pattern in Baidu Inc (NASDAQ:BIDU) stock 7 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market.

The strategy won't work forever, but for now it is a momentum play that has not only returned 294%, but has also shown a win-rate of 87.5%.

Earnings for BIDU are due out on 10-26-2017 before the market opens (BMO), based on data from our earnings date provider Wall Street Horizon. 7-days before 10-26 is 10-19.

The logic behind the option trading backtest is easy to understand -- in a bull market there can be a stock rise ahead of earnings on optimism, or upward momentum, that sets in the one-week before an earnings date. Now we can see it in Baidu Inc and we again note that the last earnings result may be fresh in investors' minds -- that gap up.

The Bullish Option Trade Before Earnings in Baidu Inc
We will examine the outcome of getting long a weekly call option in Baidu Inc 7-days before earnings (using calendar days) and selling the call before the earnings announcement.

Here's the set-up in great clarity; again, note that the trade closes before earnings, so this trade does not make a bet on the earnings result.

We can add another layer of risk management to the back-test by instituting and 30% stop loss and a 30% limit gain. Here is that setting:

In English, at the close of each trading day we check to see if the long option is either up or down 30% relative to the open price. If it was, the trade was closed.

We found this pattern in BIDU through the Trade Machine™ Pro scanner, looking at the NASDAQ 100 and "7-day pre-earnings long calls."

And here are the results:

As Trade Machine members know well, there are a short list of momentum tech stocks that follow this pattern remarkably well.

But, this particular scan has a 40% stop and limit built into it, when we reduced the stop and limit own to 30% to account for BIDU's excessive volatility, the results got even better and that's what we are going to discuss, right now.

Here are the results over the last two-years in Baidu Inc:

BIDU: Long 40 Delta Call

% Wins: 87.5%
Wins: 7 Losses: 1
% Return:  298% 

Tap Here to See the Back-test

The mechanics of the TradeMachine™ are that it uses end of day prices for every back-test entry and exit (every trigger).

We see a 298% return, testing this over the last 8 earnings dates in Baidu Inc. That's a total of just 48 days (6-days for each earnings date, over 8 earnings dates). This has been the results of following the trend of bullish sentiment into earnings while avoiding the actual earnings result.

We can also see that this strategy hasn't been a winner all the time, rather it has won 7 times and lost 7 time, for a 87.5% win-rate.

Setting Expectations
While this strategy had an overall return of 298%, the trade details keep us in bounds with expectations:

      The average percent return per trade was 45.5%.
      The average percent return per winning trade was 57.1%.
      The percent return for the losing trade was 35.5%.

It is worth noting that when this back-test showed a loss, it was pretty substantial, so as always, use perspective in your analysis. We also note that the average return is much larger than the 305 limit because the Trade Machine uses end of day prices -- a reminder of how volatile BIDU stock can be and why we are reviewing a tighter stop and limit than usual.

Back-testing More Time Periods in Baidu Inc
Now we can look at just the last year as well, and this is where it gets so good that some good old fashioned sensibility is required.

BIDU: Long 40 Delta Call

% Wins: 100%
Wins: 4 Losses: 0
% Return:  232% 

Tap Here to See the Back-test

We're now looking at 232% returns, on 4 winning trades and 0 losing trades. It's worth noting again that we are only talking about one-week of trading for each earnings release, so this is 232% in just 4-weeks of total trading.
      The average percent return over the last year per trade was 73.4%.

Bull markets tend to create optimism, whether it's deserved or not. To see how to test this for any stock we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work

Risk Disclosure
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.

Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.