L-3 Communications Holdings Inc (NYSE:LLL) : The One-Week Pre-earnings Momentum Trade With OptionsDate Published: 2018-02-19
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.
There is a bullish momentum pattern in L-3 Communications Holdings Inc (NYSE:LLL) 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, and in fact, it hasn't even won more often than it has lost. But since the winning trades are so much larger than the losing trades, it has returned 189.8% even with a win rate that isn't above 50%.
This same strategy also worked in the throws of the bear market from 2007-2008, and we disucss those results near the finale of this article.
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 L-3 Communications Holdings Inc.
The Bullish Option Trade Before Earnings in L-3 Communications Holdings Inc
We will examine the outcome of getting long a weekly call option in L-3 Communications Holdings 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 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.
Here are the results over the last three-years in L-3 Communications Holdings Inc:
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 189.8% return, testing this over the last 12 earnings dates in L-3 Communications Holdings Inc. That's a total of just 84 days (7-days for each earnings date, over 12 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 6 times and lost 6 times, for a 50% win-rate and again, that 189.8% return in less than six-full months of trading.
While this strategy had an overall return of 189.8%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 23.64%.
Is This Just Because Of a Bull Market?
It's a fair question to ask if these returns are simply a reflection of a bull market rather than a succesful strategy. It turns out that this phenomenon of pre-earnings optimism also worked very well during 2007-2008, when the S&P 500 collapsed into the "Great Recession."
The average return for this strategy, by stock, using the Nasdaq 100 and Dow 30 as the study group, saw a 45.3% return over those 2-years. And, of course, these are just 8 trades per stock, each lasting 7 days.
* Yes. We are empirical.
* Yes, you are better than the rest now that you know this.
* Yes, you are powerful for it.
Bullish momentum and sentiment ahead of earnings has been, empirically, a repeating pattern both in a bull and bear market for some companies. This is just one example of what has become a tradable phenomenon in L-3 Communications Holdings 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.