Monday, July 12, 2010

Earnings Season Primer

With tonight's report from Alcoa, earnings season is officially upon us. Last time I checked AA was up 3% after hours, so it seems the market liked the announcement. What exactly was their revenue and EPS you ask? Well, beats me. All I care about is the price action. Leave the actual report and fundamental hullabaloo to number crunchers smarter than me.

In the past I've done my fair share of earnings play posts. Matter of fact, earnings plays have almost received the most face time on Tyler's Trading, coming in at number three within my labels widget just behind the SPX and VIX. So perhaps I'll dust off the 'ole earnings playbook and take a look at a few of the bigger names this go around. For those inclined to try their luck at gaming the earnings gap, keep these three truisms in mind:

1. Implied volatility is virtually always elevated into earnings as the option market seeks to adequately price in the magnitude of the earnings gap.

2. Implied volatility drops precipitously following earnings as options revert back to pricing in a stock's normal volatility.

3. Volatility sellers have the edge going into earnings. More times than not short vol strategies will yield a profit while long vol plays result in a loss. The fly in the ointment arises when assessing the average gain versus loss. Take short strangles for instance. Though you'll probably win roughly 2/3 of the time, the occasional loss can quickly overwhelm your gains. In the long run selling volatility into earnings is likely to be a zero sum game. In the end, trading them profitably comes down to proper position sizing, sound risk management, and a dash of good fortune.

For other earnings related posts, readers can check out:
Earnings... The Wrench in the Theta Clock
Volatility Crush
Lessons Learned From a Trip to the Woodshed
Wildest Dream of Worst Nightmare

1 comment:

QUALITY STOCKS UNDER 5 DOLLARS said...

Earnings are sometimes good and sometimes bad.