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By: Costas Bocelli — July 25, 2012

Your Most Powerful Tool for Earnings Season

If you’re looking for an edge to help you make better trading and investment decisions, then you’ve come to the right place today.

Because I’m going to share with you a down and dirty professional secret that can help you quantify a future potential move in a stock’s price ahead of a defined event.

And after I reveal this helpful tip, I’ll share with you a timely example that you’ll be able to follow along with and see how it plays out very shortly... starting soon after today’s market close!

We’re now entering the heart of earnings season, as hundreds of companies are reporting second quarter (calendar) results over these couple of weeks.

And chances are that several stocks that you either own or may have an interest in will soon be reporting too.

The thing about earnings season -- which comes around four times a year -- is that individual stocks tend to make some of their biggest one day moves of the year after the results are released.

And for the average investor, the price action volatility which normally ensues can be an anxious moment.  And why not?  We're heading into a known event (earnings release), but one that will likely trigger a significant unknown reaction (stock price movement). 

But what if you had a tool that could help you gauge that unknown reaction before the earnings release?

Think about how powerful this information could be to you.  Whether you care to act before the earnings release or after, key price levels will be uncovered to you that are otherwise hidden to the majority of the investing public.

In other words, the tool that I’m going to share with you will help you gauge the magnitude of the stock price movement from the upcoming market reaction to the earnings event.

For me, that’s powerful information to get your hands on, and a huge edge to discover!

One thing to remember is that it’s a tool, albeit a great one.  Like all other forecasting tools, it’s not 100% foolproof.  But what I can attest to is that, in my years of experience, it’s been more reliable than not and quite uncannily effective at predicting the magnitude of price movement.

Here’s How it Works:

The tool involves pricing an options straddle on the underlying stock that will be reporting earnings. 

It’s quite simple.  If you can add two numbers together, you’re halfway there.  The other half is to properly identify which straddle to focus on.

A straddle is the simultaneous purchase of a Call option and a Put option with the same strike price and same expiration date.  The straddle can also be sold, but all we’re really interested in is simply obtaining the market value of the straddle, or the mid-price between the bid/ask spread.

So let’s identify the proper straddle.

With respect to which strike price, we want to focus on the at-the-money strike, or the strike price that’s closest to the current price of the stock.

With respect to the expiration date, we want to focus on the closest expiration date that captures the earnings release -- the closer the better.  The good news is that weekly options (expire every Friday) are listed on many widely followed stocks, making it a much more reliable tool.

From there, we simply add the value of the Call option and the Put option together and we priced the straddle.  And that sum just unlocked the information we’re looking for.

The value of the straddle essentially acts like a breakeven around the strike price we focused on, and since the strike price is closest to the current stock price, it’s also acting as a breakeven around the stock price too.

Also, since we are focusing on an expiration date that will come very shortly after the earnings release, the value of the straddle is essentially a major clue as to the magnitude of the stock price move that's likely coming after the earnings release.

So the straddle is basically giving you a peek “behind the curtain” at where the smart money is hidden, for free!

A Timely Example:

After the close today, Amazon.com (AMZN) will release their quarterly earnings results.

Wall Street is looking for $12.89 billion in revenue, which will be more of the focus than the 0.02 earnings per share bottom line estimate.

So how much is AMZN going to move on the earnings release?

My guess is that the stock is going to move 9% on the news.  How do I come up with this?  By pricing the appropriate straddle and taking advantage of the information in the options market.

Yesterday, I looked at AMZN when it was trading around 216.00 per share.

The AMZN July 27, 2012 weekly 215 straddle (expires tomorrow) was trading at 19.00.

It’s the proper straddle to focus on, as the 215 strike is close to the current stock price and the weekly expiration tomorrow of the straddle essentially is pricing the earnings move in the stock price.

So come tomorrow, this tool is telling us that the magnitude of the move should be (+) or (-) 19 points from the 215 strike (shown by the red dotted line in the chart below).  If the price action is bullish, AMZN should trade around the 234 level.  And if the price action is bearish, the selling pressure should take the stock down to the 196 level (both target levels are shown by the blue lines).

Also pay attention in the after hours market and see how the price action behaves around these key levels -- you may find it very telling.  Management will be hosting their conference call after the earnings release and during extended hours trading.

While this tool is indeed a reliable indicator in helping you gauge the magnitude of an earnings move, it does not indicate a specific direction.  But whether it’s a bullish or bearish move, knowing these key levels can be a huge advantage, as you have discovered exactly where the hidden pressure points are located.

It’s powerful information that you access quick, easily and for free -- even without having to trade or risk one penny in the options market.

Enjoy your new edge!

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