How to Trade Bearish Momentum in NetEase After an Earnings Gap Drop
Date Published: 2018-11-02
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.
LEDENetEase, Inc. (NASDAQ: NTES) is a leading internet technology company in China, and with that market in full blown panic, this time we will look at a bearish momentum pattern 1 trading day after earnings, if and only if the stock showed a large gap down after the actual earnings announcement.
This is a conditional entry -- the company reports earnings and if the stock move off of that report is a 3% loss or larger, then a bearish position is back-tested looking for continuing downward momentum. The event is rare, but when it has occurred, the back-test results are noteworthy.
NTES next has earnings due out on 11-14-2018, and one day after that would be 11-15-2018.
NetEase Inc (NASDAQ:NTES) Earnings
In NetEase Inc, if the stock move immediately following an earnings result was a large drop (3% or more to the downside), when we test waiting one-day after that earnings announcement and then bought a three-week out of the money (40 delta) put, the results were quite strong.
This back-test opens one-day after earnings were announced to try to find a stock that continues a downward spiral after an earnings gap down.
Here is the timing set-up around earnings:
And here is the pattern we are after in Net Ease, looking at just the last two earnings periods:
Rules* Condition: Wait for the one-day stock move off of earnings, and if it shows a 3% loss or more in the underlying, then, follow these rules:
* Open the long out-of-the-money put (40 delta) one-trading day after earnings.
* Close the long put 14 calendar days after earnings.
* Use the options closest to 14 days from expiration (but more than 14 days).
This is a straight down the middle direction trade -- this trade wins if the stock is continues on a downward trajectory after a large earnings move the two-weeks following earnings and it will stand to lose if the stock rises, instead. This is not a silver bullet -- it's a trade that needs to be carefully examined.
But, this is a conditional back-test, which is to say, it only triggers if an event before it occurs.
RISK CONTROLSince blindly owning put can be a quick way to lose in the option market, we will apply a tight risk control to this analysis as well. We will add a 40% stop loss and a 40% limit gain.
In English, at the close of every trading day, if the put is up 40% from the price at the start of the trade, it gets sold for a profit. If it is down 40%, it gets sold for a loss. This also has the benefit of taking profits if there is a stock decline early in the two-week period rather than waiting to close 14-days later.
Here are the results of a long out-of-the-money put in NetEase Inc (NASDAQ:NTES) over the last two-years but only initiated after earnings if the stock dropped by 3% or more:
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).
Looking at AveragesThe overall return was 295%; but the trade statistics tell us more with average trade results:
➡ The average return per trade was 76.1% over each 13-day period.
➡ The average return per winning trade was 107.7% over each 13-day period.
➡ The average return per losing trade was -50.4% over each 13-day period.
WHAT HAPPENEDThis is how people profit from the option market. Take a reasonable idea or hypothesis, test it, and apply lessons learned.
Tap Here, See for Yourself
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.