Stewart Information Services Corporation (NYSE:STC) : The One-Week Pre-earnings Momentum Trade With OptionsDate Published: 2018-04-20
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 Stewart Information Services Corporation (NYSE:STC) 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 136.6% even with a win rate that isn't above 50%.
This same strategy also worked in the throes of the bear market from 2007-2008, and we discuss 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 Stewart Information Services Corporation.
The Bullish Option Trade Before Earnings in Stewart Information Services Corporation
We will examine the outcome of getting long a weekly call option in Stewart Information Services Corporation 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 Stewart Information Services Corporation:
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 136.6% return, testing this over the last 12 earnings dates in Stewart Information Services Corporation. 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 136.6% return in less than six-full months of trading. The trade will lose sometimes, but over the most recent trading history, this momentum and optimism options trade has won ahead of earnings.
While this strategy had an overall return of 136.6%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 61.72%.
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 successful 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.
Back-testing More Time Periods in Stewart Information Services Corporation
Now we can look at just the last year as well:
We're now looking at 67.5% returns, on 2 winning trades and 1 losing trades.
➡ The average percent return over the last year per trade was 58.73%.
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 Stewart Information Services Corporation.
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.