Trading Momentum into Earnings Optimism With Options in Red Hat Inc



Red Hat Inc (NYSE:RHT) : Trading Momentum into Earnings Optimism With Options

Date Published:

Disclaimer
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.

PREFACE
There is a powerful pattern of optimism and momentum in Red Hat Inc (NYSE:RHT) stock right before of earnings, and we can capture that pattern by looking at returns in the option market. The strategy won't work forever, and in fact, it hasn't even won more often than it has lost, but since this strategy has a celever risk control, the winning trades are so much larger than the losing trades, that it has returned 967% annualized returns.

PREMISE
The premise is simple -- one of the least recognized but most important phenomena surrounding this bull market is the amount of optimism, or upward momentum, that sets in the two-weeks before an earnings announcement.

That is, totally irrespective of whether the stocks have a history of beating earnings, in the two-weeks before of earnings, several of them tend to rally abruptly into the event. There has been a way to profit from this pattern without taking any actual earnings risk -- and it is very powerful in Red Hat Inc.



The Options Optimism Trade Before Earnings in Red Hat Inc
Let's look at the results of buying a monthly call option in Red Hat Inc two-weeks 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.

Here are the results over the last three-years in Red Hat Inc:

RHT: Long Call

% Wins: 50%
Wins: 6 Losses: 6
% Return:  444.9% 
% Annualized:  967% 

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 444.9% return, testing this over the last 12 earnings dates in Red Hat Inc. That's a total of just 168 days (14 days for each earnings date, over 12 earnings dates). That's an annualized rate of 967%. That's the power of following the trend of optimism into earnings -- and never even worrying about the actual earnings result.

We can also see that this strategy hasn't been a winner all the time, rather it has won 6 times and lost 6 times, for a 50% win-rate and again, that 444.9% return in less than six-full months of trading.

Setting Expectations
While this strategy had an overall return of 444.9%, the trade details keep us in bounds with expectations:
      The average percent return per trade was 29.55%.


Checking More Time Periods in Red Hat Inc
Now we can look at just the last year as well:

RHT: Long Call

% Wins: 50%
Wins: 1 Losses: 3
% Return:  44.3% 
% Annualized:  289% 

Tap Here to See the Back-test

We're now looking at 44.3% returns, on 1 winning trades and 3 losing trades. It's worth noting again that we are only talking about two-weeks of trading for each earnings release, so this is 44.3% in just 8-weeks of total trading which annualizes to 289%.
      The average percent return over the last year per trade was 11.13%.

WHAT HAPPENED
Bull markets have quirks, or personalities if you like.

The personality of this bull market is one that shows optimism before earnings -- irrespective of the actual earnings result. That has been a tradable phenomenon in Red Hat Inc.

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.