The Gap Up - Then Five-Days Pre-earnings Momentum in Guidewire Software IncDate Published: 2018-05-29
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.
Guidewire Software (GWRE) is a little followed tech stock that has been ripping to all-time highs. It does have a pre-earnings momentum pattern, but it has had a rarely seen but more powerful pattern when it is coming off of a large gap up from the prior earnings cycle. For the first time in two-years, we see that phenomenon, right now.
According to our data provider, Wall Street Horizon, Guidewire Software Inc (NYSE:GWRE) has earnings due out on 6-5-2018 after the market closes. Five-days before then would be 5-31-2018, near the market close.
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 before an earnings date. Our empirical research has shown that this phenomenon has been statistically significantly stronger when the prior earning move was a gap up.
Here is an one-year stock chart of GWRE:
We can see that the latest earnings move was a gap higher. The stock went from $85.23 before earnings, to $91.17 the day after -- so a gap up. Remember that as we go through this back-test. As an aside, note that the stock has clipped new all-time highs since that earnings beat. Here is a 5-year chart to more clearly see that phenomenon:
The Bullish Option Trade Before Earnings in Guidewire Software Inc
We will examine the outcome of getting long a monthly call option in Guidewire Software Inc 5-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 since GWRE announces earnings after the market close, this 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 50% stop loss and a 50% 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 50% relative to the open price. If it was, the trade was closed.
Here are the results over the last three-years in Guidewire Software Inc:
The mechanics of the TradeMachine® Stock Option Backtester are that it uses end of day prices for every back-test entry and exit (every trigger).
While we see a 3% return, testing this over the last 12 earnings dates in Guidewire Software Inc, with a 75% win-rate. We also see a 56% average return over each 6-day period.
But now we can make an adjustment to the back-test to only look at this pre-earnings momentum if the prior quarter showed a large stock gap up -- which is exactly what we have right now.
Now, let's look at the results over the same three-year period, but only testing an entry for momentum if the prior quarter showed a 3% stock rise or more off of the earnings announcement.
This has only happened three-times in the last three-years, but when it has, we now see a 100% win-rate, and the average return per trade over each 6-day period was 72%.
There's a lot less luck to successful option trading than most people realize and this is it.
To learn more about empirical option trading we welcome you to watch this quick demonstration video:
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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.