How to Play this Earnings Season

2020-05-01 | Allison Ostrander

As earnings season starts off, many traders are wondering just how to trade it in this pandemic. We have experienced the most dramatic monthly range that we have seen in the last twenty years due to Oil and the Coronavirus and it put a halt to many countries’ local economies.

Manufacturing started to come to a halt. Airplanes in hangers, cruise ships in harbors, and bars and restaurants closed or only doing deliveries and take out. Even though we started to identify a low in the market and have rebounded quite nicely, the questions that remain on the top of traders’ minds are:

1. Will this rebound last into a potential V shape recovery?

2. How will earnings affect this bounce up?

Though it is still uncertain whether or not this is a V shape recovery, we have started to get a glimpse of how the market is reacting to earnings announcements.

In the case of NFLX, the price never dropped as dramatically as some of it’s FAANG counterparts, being a preferred “Stay at Home” Stock to pick. NFLX even saw a beautiful run higher into the earnings announcement itself. Then the announcement came. The numbers looked great, and even though the price technically bounced up from the prior trading day, overall the daily chart showed consolidation and NFLX running out of steam. Part of this is because the earnings price had already been put into consideration on the run higher into the announcement. You may say the market anticipated it would do well due to the nature of it being a “Stay at Home” stock to begin with. From there we have seen a healthy retracement in NFLX back to support, while the overall trend still remains bullish.

NFLX

Another recent earnings announcement was GOOGL. Now even though GOOGL is a fellow FAANG stock, it was not a “Stay at Home” Stock like NFLX was. GOOGL was certainly more affected by the downturn in the market as concern gripped traders around concerns that their ad revenue would be down as many businesses were put on hold. This of course is one of the driving factors for their profits, and though GOOGL got a bounce back up into earnings, it was not nearly as strong as NFLX. When the announcement came out that GOOGL did better than expected on ad revenue, after hour prices shot up and there was a health gap to the upside the next day. However, by the end of the day sellers had the price closing in the bottom 50% of the trading range. It is currently trying to maintain the 100 SMA as support, so we will see this week into next if it will hold, but the Bearish Divergent Bar printing into the close does show some weakness or another potential sign for a pause at this level.

GOOGL

Other Companies like FB and MCD reported earnings overnight. FB also did better than Wall Street’s expectations and gapped up after hours, while MCD showed a strong hit for the coronavirus and traded slightly lower in after hours.

So what does all this mean? To me it looks like we are seeing moves occur the majority of the time within the expected range of earnings. For those that were anticipated to do good like “Stay at Home” Stocks, or those anticipated to do bad, like restaurants or travel, the move has already been traded into the announcement. This is whether the price saw a strong sell off when the market turned bearish, or if they instead had a strong bounce back up once support held.

The symbols that were anticipated to be hurt by the coronavirus, or were uncertain, and did better than expected see a move up the next day, but so far still within the anticipated weekly range, and perhaps even some consolidation pullback once the initial move from the announcement occurs.

When I take these observations into consideration, it makes me want to take theta positive trades to hold through the earning announcement. Trades like Vertical Credit Spreads or Unbalanced Butterflies for a Net Credit. With all the premium built into these options due to the recent volatility and run higher into the earning announcement, there can be some nice credit to be taken in with Out of the Money Strikes. If the announcement creates a price move at or smaller than the anticipated range, the trade has a great probability of staying out of the money. Once that announcement also occurs, all the Out of the Money Strikes will experience that theta decay a lot more quickly, allowing for an overall profit.

No matter what, holding a trade through earnings is risky and should be considered a “Lotto Trade” where you only risk 100% of the capital if you are willing to lose. If you normally put $1000 into a new trade idea, you may consider only putting in $500 or less on a lotto trade, being okay with losing that total amount of money.

As always traders, may the trade be with you!