Earnings Season Trading Strategy
2019-05-06 | Simpler Trading Team
Find Out What Drives Earnings Season
Earnings season happens following every quarter of the calendar year when companies must file financial reports required by the federal government. The earnings call calendar generally runs from two to five weeks following the end of the previous quarter.
For example, the first quarter (Q1) earnings cycle starts around the second or third week of April and runs into the first to middle part of May. Following suit, the second quarter (Q2) earnings period follows in mid-July through the first part of August. Third and fourth quarter (Q3 and Q4) follow the same time frames to complete the earnings season calendar.
Earnings report filings for the majority of U.S. companies fall within a traditional 12-month calendar year. A few industries, such as retail, file quarterly earnings about a month after other companies.
The federal Securities and Exchange Commission (SEC) requires all publicly-traded companies to disclose quarterly earnings reports as part of financial standards.
Quarterly filings are not required on official dates, so earning season can be a daily rollout of earnings statements from many companies within the quarterly cycle. Banks tend to start off earnings season with reports following the first quarter.
Companies relay quarterly filings through a combination of press releases, SEC filings, and earnings calls which may have comments and discussions with company management. There is no standard filing format other than the mandatory SEC report.
What’s in the Report?
Earnings statements will contain profit and loss from the previous quarter or year within a combination of quarterly sales and profits.
The market can be panicky or harsh in how it responds to these earnings announcements. An unexpected report of losses could send share prices stumbling. If a company doesn’t meet expectations, the price could tumble despite posting a profit. Stronger than expected earnings can send share prices soaring beyond all expectations as traders buy into the profit.
As the market churns following news from quarterly filings, experienced traders will already have a plan in place that includes analysis of the market leading into the earnings season.
This is a point of caution for any trader. Trading solely on the news of a quarterly report - or the expectation of a quarterly report - can be costly. Earnings season is a time of potential profit, but don’t let emotion or fear of mission out overtake your trading decisions.
Experience shows it is better to plan trades ahead of time rather than jump on an earnings reports today.
Let’s take a look at trading patterns that follow the formula: high reward potential backed by limited risk and market timing.
Don’t Underestimate The Difficulty Of Trading During Earnings Season
Trading options during earnings season can be deceptively difficult. Traders must be committed to succeeding during this volatile time in the market. It’s not a time for uncertainty and doubt. People tend to see success in trading as a straight line rocketing along with highs in the market. It’s not that clear.
Real Risk, Real Fast
Reality reveals that successful trading looks more like a boxer getting repeatedly knocked upside the head and ultimately winning a fight on scoring.
The boxer never knocked out his opponent, but he had more punches land (trading wins) than he did punches hitting him (trading losses). Trading is a series of starts, stumbles, failures, starting again, gaining momentum with wins, and ultimately trading for a profit.
Remember, boxers work hard preparing for the match, mix it up in the fight, and if they score well they can achieve the winning prize. The trading life during earnings season is similar.
The run into earnings season for any stock selection moves quickly as the report date approaches and fades just as fast. Traders must be on their feet.
Earnings season’s fast pace requires you to be better prepared to avoid common trading disasters. Have a plan to win no matter what punch the market throws at you.
Faster and better technology allows traders to see more details about what’s happening in the market in real time. But traders can get overwhelmed. Paralysis by analysis can take hold and you could get knocked out of the market.
Like a boxing match, trading during the earnings cycle also requires you to protect yourself with strategies designed to limit risk. Your trades should be winning more often than not.
3 Phases Of Earnings - Watch The One With Higher Potential
All traders are watching the same markets, but everyone will trade differently. The goal is to identify what works best for you and plan your trading. Top traders at Simpler Trading follow three key time periods to trade earnings, and focus on profit opportunities.
The three phases of earnings season are the run into earnings season, trading the report, and after-earnings trades.
Let’s go ahead and cut out the phases of the cycle with less probability of reward.
Trading the report and after-earnings trades can be fun and exciting - when they work. These latter phases are not our focus because of lower probability of success and volatility that can be overwhelming, especially to newer traders.
The run into earnings is where we plan our options trading prospects.
Historically, strong stocks with bullish sentiment will trade higher leading into the report. We always identify these stocks long before the earnings report date. The few weeks leading to the earnings report tend to be the most consistent and lucrative opportunities.
What makes us so confident about this phase of earnings season?
Keep in mind, we’re not watching every stock. A solid run into earnings is to follow stocks with specific traits.
We want to identify companies with shares showing bullish signals leading into earnings dates. These stocks will exhibit a solid uptrend backed by stearn technical analysis. We’re watching strong indicators that track support, resistance, and moving averages. The goal is to identify an entry time and plan to exit the trade before the earnings report is released.
Remember, there is no way to know what the report will say and how it will affect the stock price after the report.
The run into earnings focuses on rigorous stock selection and opportune timing when entering and exiting the market.
Learning the role Implied Volatility (IV) plays in identifying a bullish stock is the power punch in or earnings formula.
When selecting stocks during the earnings cycle, keep in mind that implied volatility rises as a stock moves toward the earnings report filing date. Bullish stocks will rise as IV intensifies.
Chart indicators can track this noticeable rise and deliver insight into when a trade should be taken. A basic strategy is to buy call options when IV and stock prices are rising, set a target profit goal, and then sell if that target is hit before the earnings report.
One thing traders can count on is Implied Volatility dropping after the earnings report. We refer to this as the IV crush.
This sudden IV collapse destroys the premium in the options price, i.e. the option is worthless.
For traders without this knowledge of IV and without a stern exit plan, holding options into earnings can rip away any hope of profitable trades.
This is the trading path we promote at Simpler Trading. Plan a trade, time the price selection (enter the trade), take the win (gains) when it meets the price target, and close out (exit the trade) before the earnings report.
Whether you’re trading part-time or full-time doesn’t mean you have to know everything about earnings season. But you must be rigid in your planning, analysis, and execution.
Learn how the markets work during this cycle and you can improve chances of staying on target within the flow of this volatile season.
Traders want to not only survive the market, they want to earn income. The more you understand earnings season and follow a stern trading plan, the more opportunity you have to achieve trading success.
Which Strategies Work In Earnings Season?
There’s no magic 8-ball traders can shake up and wait for a prophetic revelation to materialize and answer their stock earnings season trading questions.
Traders determined to limit risk while timing high-reward, well-planned earnings season trades can follow technical indicators and apply proven strategies to guide them.
Both of these elements within options trading can become unruly monsters if you’re not careful. Technical indicators in charting software today look more like rocket science diagrams. Following trading strategies promoted by media pundits is as frustrating as untying a knot.
At Simpler Trading our goal has always been to keep trading, you guessed it, simpler. Charting software will always gain in complexity and trading strategies can easily sound intimidating.
So, we break it down to this: understand the principles of earnings season trades and let the indicators and strategies do all the heavy mental lifting. If you attempt to over-analyze everything, you’ll find yourself suffering from trading paralysis.
Indicators Help Plot A Course
Traders use technical indicators to help them predict upcoming price changes. This technical analysis is fueled by mathematical formulas that consider factors such as price or volume of a stock or option.
Indicators are not an exact science and traders can use them in a variety of combinations. Some traders religiously follow a single indicator while others may use an intricate web of indicators overlapping each other.
Finding and testing different indicators is part of the process of developing trading skills to improve gains in the market.
Examples of indicators include:
- Phoenix Finder - Visualize hidden stock strength or weakness in a choppy market to guide stock selection. Helps traders understand money flow to identify which stocks might be ready to burn into ashes or rise into new life.
- Voodoo Lines - Trust the magic and let the complex math do its work tracking resistance and support before prices start reacting. While complex in design using Fibonacci analysis and Elliott waves, Voodoo Lines aren’t dark arts and are simple to understand and apply across all time frames.
- The Squeeze - Identifies times when the market is compressed and holding before springing into a directional move. This indicator is the edge that sent Simpler Trading to new levels of identifying opportunity right before a move in price direction. A “squeeze fire” can happen on all time frames and there can be multiple squeezes on multiple time frames.
- Earnings Analysis - Let this indicator work for you during earnings season by calculating a variety of stats surrounding a particular stock. It covers earnings gaps, pre- and post-earnings movement, and earnings dates. One view to cover a history of earnings information on your stock watch list.
- VWAP (Volume Weighted Average Price) - Average trading price of a stock or option throughout the day based on both volume and price. Gives traders insight into the trend and value of the security.
There are almost unlimited indicators available and each focuses on a particular method of analysis.
It’s helpful when determining indicators that will work for your trading goals and style if you find a trading mentor you enjoy following. A mentor will have favorite indicators you can apply to your trading efforts and you’ll gain guidance as you use them.
Strategies Can Earn Income
Indicators provide insight into price movement while strategies define how you purchase options based on expectations of a rise or fall in price.
Basic options strategies are buying calls - expecting the price to rise - and buying puts - expecting the price to fall. You’re purchasing the “option” to buy or sell at a predetermined price point in the future.
Whether you profit from your option strategy during earnings season depends on how well you predicted the move in the stock price.
More complex options strategies use a combination of buying calls and puts to maximize possible profits while buffering losses. These combinations can lessen risk by hedging against a price that moves against the expected position.
Examples of options strategies include:
- Calls and Puts - These are the building blocks of options strategies, each with potential rewards and risks. Calls depend on prices rising and puts depend on prices falling. Buying or selling these alone can be more risky compared to combining them in a defined strategy.
- Butterfly - This spread uses multiple option contracts of the same type - calls or puts - purchased at the strike price as well as the same distance above and below the strike price. All have the same expiration date. The butterfly is conservative in its approach as the goal is to limit loss but maximize chance of gain.
- Iron Condor - This is a “market neutral” trade with four contracts with the same expiration date on the same underlying security. It contains two puts and two calls at different strike prices. All the contracts are typically out of the money and designed to reduce risk yet maintain modest profit potential.
- Straddle - Traders sensing a strong move in price but not sure of the direction (like during earnings season) exercise a put and a call option. These will have the same expiration date and strike price. A significant price move in either direction delivers a gain less than the premium paid for the opposite direction.
- Strangle - The possibility of a bigger than expected move in price because of earnings reports can be addressed by purchasing or selling an equivalent number of puts and calls. These are done with the same underlying stock with the same expiration date, but all with different strike prices. Usually the put has a low strike price and the call a higher strike price.
Options strategies can be modified in unlimited ways based upon preferences of traders. Each has advantages based on how the market is moving and what is happening with a particular underlying stock.
Again, it’s helpful having a mentor to guide you through the many ways these strategies work.
You will discover that once traders experience success with a particular strategy they tend to stick with it. Favorite strategies can develop into habits, just make sure it’s a proven, profitable habit.
To help keep you on track, Simpler Trading has professional traders who are accessible for training and guidance.
Danielle Shay knows every expert was once a beginner asking many questions. As Director of Options Trading at Simpler Trading, Shay strives to be the go-to mentor for new and seasoned traders.
Shay draws from her past elementary school career and has a knack for grasping complex information and relaying the details through simple lessons. Her strict technical analysis is an ongoing guide leading to trends and directional strategies.
Shay is a frequent commentator in Simpler Trading community forums and a frequent guest on stock market and trading media programs.
Henry Gambell breaks down complicated trading scenarios like a “zen master” as he helps traders discover daily “ah ha” moments.
Gambell is the Senior Managing Director of Options Trading at Simpler Trading. Traders following Gambell soon discover he has a conservative, clear, and analytical approach to trading. Simplicity is easiest, according to Gambell, and he always considers risk to reward courses of action when trading.
Gambell daily offers insight and analysis of trade ideas within the Simpler Trading chat room. His goal is to teach others how to create a constant stream of income.
Indicators and strategies may seem like trading overload. Once traders learn the details and follow proven strategies then they can better understand the market, particularly earnings season.
The goal is to develop a deliberate plan that identifies working trades while avoiding as much risk as possible.
Manage Wins and Losses
No matter your indicators and strategies, you must have a trading plan. You must know how to enter the market and how to exit.
Sounds basic, but you’d be surprised at how most traders get into the market based on emotion or “hot news” and how many don’t have a clue how to get out before they lose big time.
Simpler Trading wants to show traders how to use a trading foundation that focuses on high reward while limiting risk and exercising well-tested trading strategies.
The goal in trading is not to be right every time, the goal is to profit through winning trades. Lessen the losses and maximize the wins. Simpler.