Tuesday, February 16, 2010

Earnings and Verticals

We've got Hewlett Packard set to report earnings tomorrow after hours. Any time a company reports earnings close to options expiration, it presents an opportunity for some interesting plays using front month options. Since there will be little time remaining between HPQ's report and February options expiration, it's a little bit easier to determine the expected move going into earnings. As shown in the graphic below, HPQ doesn't have a history of large earnings gaps, so I wouldn't be expecting anything too crazy over the next few days (click image to enlarge).

[Source: LiveVol Pro]

Friday night's Options Action gang highlighted using a vertical put spread on HPQ to profit from a bearish reaction following the announcement. The suggestion was to buy a Feb 48-47 put spread for $.30. Rather than giving my thoughts on HPQ specifically, let's broaden the conversation and discuss the notion of buying verticals into an earnings announcement. Is it a good idea?

My answer would be yes... with a caveat.

Let's start with the caveat - which is picking directions into earnings announcements. I think it's darn near impossible to accurately forecast which way a stock's going to gap after earnings. Consequently, I wouldn't spend a whole of time placing directional bets. However, if I were to do it, I certainly like the idea of using a vertical spread as opposed to buying calls or puts outright. By using a spread that involves both buying and selling options, one can drastically mitigate the affect of the post earnings volatility crush. That way I'm making more of a directional bet as opposed to a volatility one.

For related posts, readers can check out:
The Cycle of Implied Volatility
Bear Puts
Choosing Strikes for Bear Put Spreads


greg said...

To bet on earnings I've been considering tinkering with spreads between "whisper numbers" vs analyst forecasts vs the real announcement. I think by utilizing whisper numbers, one can have an edge over analyst forecasts.

Tyler Craig said...

Hey Greg. I'm all for tinkering. If you can use an assortment of earnings data to make profitable forecasts, go ahead. I'm sure there probably are a few traders that can make accurate bets into earnings. I'm just unfortunately not one of them...

greg said...

Well I was thinking of signing up for the 2weeks trial at http://www.earningswhispers.com/ to see if I could make something of it. I don't know. One of the main questions I had was which number is already discounted into the market: the forecast or the whisper number? I think a little of both.

Tyler Craig said...

That's the million dollar question. How much is priced in? If we already knew that then predicting earnings would certainly be easier. Unfortunately it's impossible to know AND even if a company blows out the numbers it could still drop in price.

Penny Stock Advice said...

I cannot believe that apple computer trades at over 400 dollars a share. The stock traded below 5 dollars as recent as 1998. What a run.