All publicly traded companies have to report their earnings each quarter. With their earning reports, come earning surprises sometimes, and the stock price can jump violently after the earning report is released, either up or down with no guarantee. The uncertainties surrounding these reports provides a perfect environment for plenty speculative plays.
The beginner might want to buy the stocks and hope the earning report is good enough the stock will rise. In my opinion this is very risky because the stock can easily jump 5% to 10% after the report. One can easily make or lose 10% of their investment. You might decide to switch to use options instead, buying calls or puts. But unfortunately many other people are thinking the same strategy and pushing the implied volatility of these options to ridiculous high, translating into very expensive options. Here I offer two of my strategies. By no means they are the best strategies and I welcome any suggestions from anyone who has better strategies.
Bull / Bear Spread
To counter the expensive options, I use spread to reduce the cost I have to pay for the options. I use short-term weekly options that expires on the same week as the report. The volatility of the options are guaranteed to drop significantly after the report, and the spread will be widened fully if the stock also gapped. The worst case is the stock jump the opposite direction, or not moving at all. In that case you lose the full debit paid for the spread, which should be small comparing to straight call/put purchase. The profit might be smaller than straight call/put purchase, but it risk much less money.
Because everyone is buying options, I might want to take advantages of those fat option premiums. By selling a call and a put simultaneously I attempt to make a directionless bet with the volatility. The IV is guaranteed to drop, hence one of my short option will guarantee to make money. The risk is the stock price gap out of option strike price by a large margin, and this might happen if the report surprises everyone. To counter this I will choose a strike price that will have low probability of being beaten. I use delta as a rough estimate of probability. If I choose a strike price with delta 10, it tells me there is only 10% of chance the stock will gap outside of this strike price. If you cannot tolerate risk, you might try short Iron Condor, although I never tried this strategy and I cannot comment on its effectiveness.
Play the Crowd
There is a third strategy which I’m still perfecting. For example, Zoom (ZM) recently reported their earning report. Fantastic report, but the price gap down 90 points. Tough crowds eh? But the behavior of this stock before the earning is very telling. The stock tanked a month ago and consolidate around 400-420 level. From the intraday chart there is clear sign of buying, indicating people are betting on the earning report (to be good). To capture this short term energy, I use a short-term 430/450 bull spread. ZM is pushed to 480 before the earning release and the spread easily captured a 20 point profit. This strategy requires one to have a feel of the market and its sentiment. This shouldn’t be difficult for one with enough experiences.
All the strategies I described above are highly speculative. A true investor never bets on earning report. He based his decision on sound analysis. But who said you can’t have a little bit fun with speculation, as long as you are using your gambling money.