Applied Materials

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The One-Week Pre-earnings Momentum Trade With Options in Applied Materials Inc

Applied Materials Inc (NASDAQ:AMAT) : The One-Week Pre-earnings Momentum Trade With Options

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.

The bullish pre-earnings momentum pattern continues to repeat this earnings season and we have another tech darling that not only has a strong back-test behind it, but a lot of other circumstantial evidence that makes the bullish pre-earnings narrative quite compelling.

There is a bullish momentum pattern in Applied Materials Inc (NASDAQ:AMAT) stock 7 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market. Even further, if we slice the risk down, we find a higher win rate which has ultimately yielded higher historical returns as well.

The earnings date for AMAT is not yet confirmed, but we have an estimate from Wall Street Horizon of 11-16-2017, so one week before would likely be in early November.

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 Applied Materials Inc.

CML Pro members know full well the thorough bullish thesis for Applied Materials, and while that thesis looks not one week into the future but rather 3-10 years, the sentiment in this sector is rightfully optimistic, and in particular for AMAT. Here is the two-year stock return chart:

Applied Materials Inc (NASDAQ:AMAT) was added to Top Picks on November 15th, 2016 for $28.71. As of today it is trading at $55.90, up 94.7%. This comes straight from our CML Pro dossier:

On September 27th, 2017, Applied held its analysts day meeting and the company surprised everyone with not just a nice presentation about its future, but also raised forecasts.

But it was the last session in the analyst day meeting that got people's attention yet more urgently because of a rather simple, but massively impactful realization that AI will require new kinds of chips.

CEO Gary Dickerson said that AI "will absolutely require new kinds of chips to be developed," unlike anything before. In fact, he noted how fast Nvidia is innovating, with its latest Volta chip holding 21 billion transistors. Applied's tools are used in the making Volta, although the CEO historically has been pretty quiet about exactly what they do or how much they make from it.

Alright that's enough of that, the point is, there is a raised forecast into this event and a bullish CEO for a company suddenly living in the artificial intelligence theme.

The Bullish Option Trade Before Earnings in Applied Materials Inc
We will examine the outcome of getting long a weekly call option in Applied Materials 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, stricter than our normal 40% / 40% rule, by instituting and 20% stop loss and a 20% 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 20% relative to the open price. If it was, the trade was closed.

We found this back-test through the Trade Machine Pro scanner. We looked at the NASDAQ 100 and the 7-day pre-earnings long call scan:

Here are the results:

We then manually tried various stops and limits and landed at 20%.

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

AMAT: Long 40 Delta Call

% Wins: 87.5%
Wins: 7 Losses: 1
% Return:  375% 

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 375% return, testing this over the last 8 earnings dates in Applied Materials 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 8 times and lost once, for a 87.5% win-rate.

Setting Expectations
While this strategy had an overall return of 375%, the trade details keep us in bounds with expectations:
      The average percent return per trade was 29.1% over each six-day period.
      The average percent return per winning trade was 36.5% over each six-day period.
      The percent return for the losing trade was -22.7% over the six-day period.

Back-testing More Time Periods in Applied Materials Inc
Now we can look at just the last year as well:

AMAT: Long 40 Delta Call

% Wins: 75.00%
Wins: 3 Losses: 1
% Return:  168% 

Tap Here to See the Back-test

We're now looking at 168% returns, on 3 winning trades and 1 losing trade.
      The average percent return over the last year per trade was 34.5% over each six-day period.
      The average percent return over the last year per winning trade was 53.6% over each six-day period.
      The percent return over the last year for the losing trade was obviously the same -22.7% over the six-day period.

Note: Since the Trade Machine uses end of day prices, closing trades can be well through the 20% stop or limit if there was a large one-day move in the option value.

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.