Date Published: 2017-06-26
Written by Ophir Gottlieb
This is a continuation of our discussion on Alphabet Inc (NASDAQ:GOOGL).
There is a powerful pattern in Facebook Inc (NASDAQ:FB) stock ahead of earnings that has meant a wonderful return in the option market. The strategy won't work forever, but for now it appears to be a momentum play.
As we discussed with Alphabet Inc, one of the least recognized yet most important phenomena surrounding this market run by the mega technology stocks is the amount of optimism 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 Facebook Inc (NASDAQ:FB).
The Trade Before Earnings
Let's look at buying a monthly call option in Facebook Inc two-weeks before earnings 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 result of the earnings result.
Now, unlike many of our other set-ups, this is in fact a straight down the middle bullish bet -- this absolutely takes on directional stock risk, so let's be conscious of that before we see the results, because they are mind bending.
Here are the results over the last two-years in Alphabet Inc:
The trade has won 6 of the last 8 earnings pre-earnings cycles -- so this isn't some silver bullet (6 wins, 2 losses). But, the trade has won 75% of the time, and the return has been a staggering 670%.
The fascinating part here is that each winning trade averaged more twice as much as the losing trades, or in English, this trades wins 3 times more often it loses and the wins are twice as large as the losses, and that's how you find a trade with a 670% return.
Note on Risk Reduction
As a point of note, when we run this back-test using a limit gain of 30%, or in English, we close the position if it is ever up 30%, we avoid one of the losses, and this turns into a strategy that has won 7 of the last 8 earnings cycles:
We note here that the Alphabet Inc (NASDAQ:GOOGL) long call ahead of earnings also won 7 of the last 8 times and the losing quarter for GOOGL was not the same losing quarter for FB, so if these two were used together as a portfolio of pre-earnings calls, the combined strategy would have won all 16 times (eight quarters each).
Checking More Time Periods
Now we can look at just the last year as well (using no stops or limits):
We're now looking at 324% returns on 4 winning trades and 0 losing trades. It's worth noting again that we are only talking about two-weeks of trading for each earnings release, so this 324% in just 8-weeks of total trading.
For completeness, we include the results over the two most recent earnings events (6-months).
That's 294% on 4-weeks of trading without once taking the risk of an actual earnings release.
Bull markets have quirks, or personalities if you like. The personality of this bull is mega cap tech heavy and full of optimism before earnings -- irrespective of the actual earnings result.
This is how people profit from the option market -- it's preparation, not luck. To see how to do this for any stock and for any strategy, including covered calls, with just the click of a few buttons, we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work
Thanks for reading.
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.
The author has no position in Facebook Inc (NASDAQ:FB) as of this writing.
Go to the back-test link