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An Options Technique So Easy a First Grader Could Do It

By Costas Bocelli July 21, 2022 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

 

It’s mid-July and we’re in the heat of earnings season as hundreds of companies get ready to report Q2 results. 

Companies have been dealing with a lot of different factors this year. 

The Fed is aggressively hiking interest rates. The US Dollar’s strength is at a 20-year high and inflation has reached a 40-year high. Supply chain disruptions still echo across the globe, not to mention slowing (or negative) economic growth. 

This market is a different beast (or bear). It’s even different from Q1 earnings season, so we could be in for plenty of surprises and some big moves in reaction to the incoming information. 

Regardless of what kind of market we’re in, stocks often make some of the biggest one-day moves, both to the upside and downside, directly following earnings.

And self proclaimed market wizards peer into their ‘crystal balls’ to predict which companies will beat or miss expectations for Q2. 

Most of these armchair Nostradamuses are full of it (or full of something that rhymes with ‘it’). They’re groping in the dark. 

“Market gurus” get caught up in faulty technical analysis to offer explanations as to why big companies like Apple (AAPL) or Amazon (AMZN) will miss or beat expectations. 

But I’m here to tell you that you don’t need their help.

You don’t need a crystal ball, or any deep technical analysis, that takes years of practice and experience to learn. 

Believe it or not, it is much easier than that.

In fact, it’s just basic math. Simple addition. So easy, a first grader could do it. 

(Click to enlarge image)

I learned this forecasting technique back in the 1990s during my training on the Philadelphia Stock Exchange and I still use it daily. It was probably the single most important lesson that contributed to my success. 

This is a technique the guys on Wall Street don’t want you to know. They don’t want you to know how simple it is. 

But sticking with the values of True Market Insiders, I’m here to show you how to use this technique to predict the future price movement of a stock

This technique can be applied to thousands of publicly traded companies. You don’t have to be a seasoned options trader to utilize this technique. As a matter of fact, you can use it even if you’ve never traded an option contract in your life. 

It starts with two numbers you need to add together. The sum of those numbers will help you make better investment decisions. 

Over the next week, as earnings results pour in, you’ll get to see for yourself how reliable this predictive indicator can be

In the coming week, 167 companies in the S&P 500 and 12 companies of the Dow Jones Industrial Average will report financial results. 

We’ve already seen huge companies make big post-earnings moves. 

On July 14th, JP Morgan (JPM) added $428 million in loan loss reserves which caused the company to miss earnings estimates. The result? Its stock dropped 5%. 

IBM (IBM) dropped more than 7% after taking a strong dollar hit to 2022 revenue. 

The idea here is to try and gauge how big of a move a stock might make before earnings are made public.

Let me share a timely example so you can see how this technique works in a live market setting. 

The “Straddle” Strategy 

The technique involves identifying the price of an option “straddle” on the underlying stock. 

A straddle is the value of a Call option plus the value of a Put option that has the same strike price and the same expiration date. 

A straddle can be bought or sold, but with regard to this technique, we’re only interested in knowing the fair market value (mid-price or “mark”) of the straddle. 

In many cases, you’ll have a variety of options to choose from. So, with this technique you need to be sure you focus on the right ones. 

This involves two easy steps:

First: Locate the Call option and the corresponding Put option with the strike price closest to the current market price of the stock. These options are considered to be at-the-money

Second: Pick the expiration date. The closer the expiration date is to the earnings date, the better. 

In a perfect world, you’ll find an expiration date that comes shortly after the earnings event. But it’s extremely important that the expiration date captures the earnings catalyst

Most widely traded stocks offer weekly options that carry a very short expiration period. So, it’s very common to find a straddle that expires at the end of every trading week. 

Now that you know how to locate the most appropriate Call and Put option, all you need to do is add the value of the two together

There you have it, you have priced the straddle. 

Better yet, you’ve unlocked some very powerful information that could predict the potential move of the stock immediately following the earnings event. 

This technique gives you a sneak peak of a potential move of the stock based on what the market is implying through the lens of the options market. 

The value of the straddle is the breakeven from the strike price for this strategy. 

Since the straddle will expire shortly after the earnings event, that value is essentially pricing in the expected move of the stock. 

It gets better…

You didn’t even have to trade one option contract or risk one cent to obtain this information. 

To give you an idea of how effective this technique can be, let’s use Seagate Technology (STX) as an example. 

The stock closed at $82.07 per share on Wednesday, and it reports earnings today (Thursday the 21st) after the markets close. 

So, we’re looking at the July 22nd 82 straddle expiring tomorrow (Friday).

You’ll see that it's trading for about $5, so the breakeven is five points above 82 and five points below 82. 

That means we’re looking at a ten point range. 

So, by looking at the straddle, the options market is implying a +/- $5.00 move following earnings. 

In the event of a positive reaction, you’d focus on $87 to the upside. And in the event of a negative reaction, you’d focus on $77 to the downside. 

Whether they know it or not, these are price points that curious investors will react to. 

There is no such thing as foolproof technical analysis, or bulletproof strategies in the market. But I’ve found that straddle breakevens are extremely useful and effective in making better, more informed investment decisions. 

Now is the time of year to give it a try! Let me know how it goes. 

Got options? You should!

Costas

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