Let me start this article by saying that I have no problem with people who do this.  There are a lot of people that have made a lot of money in doing this.  And like anything, there are a lot of people that have lost a lot of money doing this as well.

I’ll start by going through ways that earnings announcements are typically played.  The first way is through the straddle.  Let’s say that XYZ stock is trading at 50/share.  The 50 call is priced at $2 per contract.  The 50 put is also priced at $2 per contract (let’s say that both options expire the day after earnings).  That means that the options market is expecting a $4 move from the earnings announcement (either up or down). 

There is one group of people that will buy both the call and the put.  If there is a move of more than $4 from the earnings announcement, then the straddle buyer is the winner as one of the options mathematically has to be worth more than $4. 

The other group is the straddle sellers.  Should the underlying have a move of less than $4 (either up or down) before expiration, then the seller is the winner as none of the options can possibly expire more than $4 in the money.

The other way to play earnings is to pick a side.  You can be either bullish or bearish.  When you pick a side, you are predicting that the earnings numbers are going to give the market a reaction either bullish or bearish.  An example of picking a side would be to either buy a call or call spread if you are bullish or a put or put spread if you are bearish.  Remember, the earnings number itself means absolutely nothing.  It is the market’s reaction to the number that is important when doing something like this.

Above are just a couple of examples on how people can play earnings announcements.  There are many more ways of doing it.  These two methods are just the very basic ways it can be done.

I want to go through the reason that I don’t want to play this game.  In doing this, let me explain my overall philosophy on investing in the U.S. stock market.  I am “long term bullish” and “short term cautious.”  I’ve been using that approach for almost my entire career. 

I’m long term bullish because the S&P 500 has an undeniable upside track record for the past 100 years.  No other major asset class has outperformed it.  It is for that reason that I am either in a bullish trade or not in a trade at all, but I’m never in a bearish trade.  Yes, there are times that the market is a bit overbought.  I recognize that.  I also recognize that there will be pullbacks.  It is for those reasons that I am short term cautious.

I’m short term cautious in that I want to always have risk management in place in one form or another.  If I feel that there has been a big market rally, I may trim some of my position.  If I feel that we had a pullback and it is an opportunity to “buy the dip”, then I may add to my position.  The point is that I want to embrace the fact that markets don’t always go straight up, and they do correct. 

Ultimately, I may trim some of my SPX positions going into earnings season as a precautionary action.  Or, I may take off some short premium positions and only use long premium positions during earnings season.  I actually do that fairly frequently. 

One thing that I will never do is add to a position in anticipation of an earnings number either bullish or bearish.  That would go against my investing philosophy as I would not be trading based on long term market strength, I would be trading based on a short term guess.

If you would like to learn more about what I do as a financial advisor, please email me at mtosaw@rcmfs.com.