Swing Trading Earnings Bullish Momentum With Options in Red Hat Inc



Red Hat Inc (NYSE:RHT) : Swing Trading Earnings Bullish Momentum With Options

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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 pattern of bullish momentum in Red Hat Inc (NYSE:RHT) stock just days before earnings, and we can track that by looking at swing returns in the option market. This is a short-term swing trade, it won't be a winner forever, and it can be easily derailed by a couple of down days in the market irrespective of Red Hat Inc news, but for now it has shown a repeating success that has not only returned 1,869% annualized returns, but has also shown a win-rate of 58%.

IDEA
The idea is quite simple -- trying to take advantage of a pattern in short-term bullishness just before earnings, and then getting out of the way so no actual earnings risk is taken.

That is, totally independent of whether the stocks have a pattern of beating earnings, in the 3-days before earnings, there is a small group that have risen sharply ahead of the actual news. It's essentially bullish optimism in a very short-term window. There has been a way to use a short-term trade and generate profits from this tendency and it does not take earnings risk.



The Short-term Option Swing Trade Ahead of Earnings in Red Hat Inc
We will examine the outcome of going long a weekly call option in Red Hat Inc just three calendar days before earnings and selling the call one day before the actual news.

This is construct of the trade, noting that the short-term trade closes before earnings and therefore does not take a position on the earnings result.



Often times we look at option set-ups that are longer-term, and take no directional bet -- this is not one of those times. This is a no holds barred short-term bullish swing trade with options and that's it. It's a bullish bet, so must be conscious of the delta risk.

RISK MANAGEMENT
We can add another layer of risk management to the back-test by instituting and 40% stop loss and a 40% 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 40% relative to the open price. If it was, the trade was closed.

RESULTS
Below we present the back-test stats over the last three-years in Red Hat Inc:

RHT: Long 40 Delta Call

% Wins: 58%
Wins: 7 Losses: 5
% Return:  122.9% 
% Annualized:  1,869% 

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 122.9% return, testing this over the last 12 earnings dates in Red Hat Inc. That's a total of just 24 days (2-day holding period for each earnings date, over 12 earnings dates). That's an annualized rate of 1,869%. That's the power of following the short-term pattern of bullishness ahead earnings -- and not taking on the actual risk from the earnings outcome.

This short-term trade hasn't won every time, and it won't, but it has been a winner 7 times and lost 5 times, for a 58% win-rate and again, that 122.9% return in less than one-full month of actual holding period.

Setting Expectations
While this strategy has an overall return of 122.9%, the trade details keep us in bounds with expectations:
      The average percent return per trade was 10.78%.


Looking at More Recent History
We did a multi-year back-test above, now we can look at just the last year:

RHT: Long 40 Delta Call

% Wins: 75%
Wins: 3 Losses: 1
% Return:  94.5% 
% Annualized:  4,312% 

Tap Here to See the Back-test

We're now looking at 94.5% returns, on 3 winning trades and 1 losing trades.
      The average percent return over the last year per trade was 21.19%.

WHAT HAPPENED
The pattern of this bull market reveals a bullish run up before earnings in the very short-term -- independent of the realized earnings result. This has been a tradable phenomenon in Red Hat Inc. To see how to test this for any stock we welcome you to watch the demonstration video.

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.