The Trading Pattern in Alphabet Right Before Earnings
Date Published: 2018-09-18
DisclaimerThe 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.
LEDEThe September and October period can be a particularly volatile period for stocks. But there's a way to test strategies that work well with that volatility. On 2018-09-18 we penned The Trading Pattern in Netflix Right Before Earnings.
It's this same pattern we now see in Alphabet Inc (NASDAQ:GOOGL). Alphabet next has earnings due out on 2018-10-25, and 30 days before then would be 9-25-2018, near the market close.
Custom TimingFirst we'll start with timing. Here it is:
The trade opens 30 calendar days before earnings and closes the day of earnings. Note that since Alphabet reports earnings after the market closes that this trade does not take on earnings risk -- it avoids it by closing before the event.
Building the Strategy Before We See the ResultsWe constructed a GOOGL multi-leg strategy, just as we did before and have done so many other times for the S&P 500 ETF (SPY), Nvidia, Micron, Netflix, Adobe, and Amazon back-tests. We have a Google sheet that can help visualize it, here: Understanding the Strategy.
Here is the entire image, and then we will break it down, leg by leg.
Rather than take this is one big trade, we can actually break it into two familiar trades. This could be one way to apply this lesson in real life. That is, open 2 put spreads.
RulesThe first leg is simply long one put spread:
* Long one 37/20 delta monthly put spread.
This is long one put spread
The second leg is simply short two put spreads:
* Short two 30/10 delta monthly put spreads.
This is short two put spreads
What Does This Mean?This is casually called a ratio put spread, and specifically this is a 1 x 2 x 1 x 2 (read out loud as "1 by 2 by 1 by 2") put spread.
The idea is to create an option position that:
* Creates a credit at onset.
* Has no upside risk (a stock rise to any price should be profitable).
* Has some downside bias (if the stock goes down "a little" it profits at the maximum level)
* Has a hard limit on total downside.
Broadly speaking, this is how all of that looks in a profit and loss chart at expiration:
This strategy is profitable in the green shaded area, and shows a loss in the red shaded area.
To get your bearings:
* The maximum loss starts at the lowest strike price. Any stock price there or lower shows a capped loss at its maximum.
* The maximum gain occurred right at the second-strike price (the first short strike price), which is below the initial stock price at onset of the trade.
This strategy does well in a bull market but does best in a slightly bearish market. It does worst when there is a large stock drop, but that loss is capped.
Finally, The ResultsHere are the results of this strategy over the last three-years, or 12 pre-earnings periods.
And finally, for completeness, over the last four pre-earnings periods :
How to Try This YourselfWe simply used the Trade Machine® Custom Strategy builder. You can create it yourself immediately as a Trade Machine member, by simply clicking on any of the back-test links above, then click the "edit" button, and save.
What HappenedIn a few mouse clicks and about 30 seconds, we identified a pattern that has repeatedly turned a profit over and over again. Tap the link below to become your own option expert.
Tap Here to Learn More
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.