Timing the Pre-earnings Momentum Trade With Options in Lam ResearchDate Published: 2018-04-10
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 Lam Research Corporation (NASDAQ:LRCX) stock 6 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market.
Lam Research is one the great tech gems, like Applied Materials (NASDAQ:AMAT), that have turned around from a cyclical story to a knock-down drag out growth story over the last few years, and while the stock price has popped, so has the pre-earnings momentum. Let's take a look at 16-month chart:
The "E" icons represent earnings dates and we can see rather clearly how the stock has a tendency to rally into the event. Also, a recent price target hike on 4-9-2018 from Evercore gives LRCX an added boost.
Let's take a casual observation and turn it into empirical data. According to our earnings date provider, Wall Street Horizon, Lam Research has earnings due out on 4-17-2018 (after the market closes). Six days before then would be 4-11-2017.
The Bullish Option Trade Before Earnings in Lam Research Corporation
We will examine the outcome of getting long a weekly, at the money, call option in Lam Research Corporation 6-days before earnings (using calendar days) and selling the call before the earnings announcement. Since LRCX reports after the market closes, we test this momentum strategy selling the call on the day earnings, but before the close.
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 60% stop loss and a 60% 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 two-years in Lam Research 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 586% return, testing this over the last 8 earnings dates in Lam Research Corporation. This has been the results of following the trend of bullish sentiment into earnings while avoiding the actual earnings result.
While this strategy had an overall return of 586%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 44.3% over each seven-day period.
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.
Bull markets tend to create optimism, whether it's deserved or not. To see how to find the best performing historical momentum, technical analysis or non-directional trades for any stock using empirical results rather than guesses, 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.