Target Corp

-1.23 (-1.48%)

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Avoid Bear Market Risk: Option Trading Before Earnings in Target Corporation

Non-Directional Back-testing

Date Published:

The results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.

While we find some great patterns in pre- and post-earnings trends, many of our favorites come with lowered risk, rather than the straight down the middle bullish bets.

But, even in that population of patterns, we have found something quite compelling, which took three extra steps of optimization that has revealed a powerful non-directional back-test result. This is a good reminder that a little bit of extra care in analysis can identify some small changes that reveal better historical results.

It turns out, over the long-run, for stocks with certain tendencies like Target Corporation (NYSE:TGT), there is a clever way to trade market anxiety or market optimism before earnings announcements with options.

This approach has returned 233% with a total holding period of just 48 days, with 7 wins and 1 loss in the last 2-years, while adjusting risk controls in a slightly different way to allow for larger upside and a quicker trigger to cut losses than we normally examine.

The Trade Before Earnings
What a trader wants to do is to see the results of buying an at the money straddle a few days before earnings, and then sell that straddle just before earnings.

This trade is not a panacea, which is to say, we have to test it, stock by stock, to see when and why it worked. We start with Target Corporation.

Here is the setup:

Change #1
While we normally check the pattern 7-days before earnings and closing the one-day before, we did little optimizing and changed the timing a bit. This time we are testing opening the position 8 calendar days before earnings and then closing the position 2 calendar days before earnings. This is still not making any earnings bet. This is not making any stock direction bet.

Risk Controls
We can add another layer of risk controls to the back-test by instituting and 25% stop loss and a 50% limit gain. Here is that setting:

Change #2
This is also different than our standard 40% stop and 40% limit -- again, we took some time to examine the trades and stock behavior before earnings, and made an adjustment that leaves a lopsided risk control -- it is stricter to the downside and leaves more room to the upside.

In English, at the close of each trading day we check to see if the long straddle is either up 50% or down 25% relative to the open price. If it was, the trade was closed.

Change #3
In this back-test we also changed from looking at monthly options, and reduced the option days to expiration to those that are closest to 14 days from expiration.

Once we apply these two additional changed rules to our back-test, we run it on an at-the-money straddle.

Trade Discovery
We first identified Target's pattern using the Trade Machine™ Pro scanner, looking at the S&P 500 and the 7-days pre-earnings straddles:

And here are selected results:

If we did this long at-the-money (also called '50-delta') straddle in Target Corporation (NYSE:TGT) over the last two-years but only held it before earnings we get these results:

Long At-the-Money Straddle

% Wins: 87.5%
Wins: 7 Losses: 1
% Return:  233% 

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 233% return, testing this over the last 8 earnings dates in Target Corporation. We can also see that this strategy hasn't been a winner all the time, rather it has won 7 times and lost once.

Setting Expectations
While this back-test has an overall return of 233%, the trade details keep us in bounds with expectations:
      The average percent return per trade was 33.4% per six-day period.
      The average percent return per winning trade was 39.5% per six-day period.
      The average percent return for the losing trade was -9.9% per six-day period.

While we love seeing positive returns, one eye-catcher here was the size of the losing trade -- which is to say, historically it has been well controlled.

Option Trading in the Last Year
We can also look at the last year of earnings releases and examine the results:

Long At-the-Money Straddle

% Wins: 100.00%
Wins: 4 Losses: 0
% Return:  120% 

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In the latest year this pre-earnings option trade has 4 wins and lost 0 times and returned 120%.
      Over just the last year, the average percent return per trade was 30.4% per six-day period, which is comfortably similar to the two-year average of 33.4%.

This is it -- this is how people profit from the option market -- finding trading opportunities that avoid earnings risk and work equally well during a bull or bear market.

To see how to do this for any stock we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work

Thanks for reading.

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.