Trading stocks around earnings announcements is complicated. Nevertheless, we’re going to take advantage of lower- than-average longer-dated options premiums in an e-commerce payment services company to frame a modestly bullish bet going into earnings. Stock investing is challenging. Investing ahead of a catalyst, such as earnings, even more so. Some of the more significant challenges associated with trying to trade stocks ahead of, or going into, earnings include: Volatility Increased price swings: Earnings announcements can lead to heightened volatility in a stock’s price. Positive or negative surprises in earnings results can cause sharp moves in either direction, which can be difficult to predict and manage. Options pricing: For options traders, this volatility can lead to increased options premiums, making it more expensive to enter long positions ahead of earnings or occasionally tempting traders to “yield chase” by selling premium the trader perceives as rich because it is higher than usual. Uncertainty and Surprises Unpredictable outcomes: Predicting what a company will report for earnings or what management might say on an earnings call is hard enough. Correctly anticipating how the market will react to what they report or say is harder still, even with a thorough analysis. Companies might beat earnings expectations but still see their stock price fall due to other factors like future earnings guidance, revenue quality, or broader market conditions. Guidance: Companies often provide forward-looking statements or guidance about future earnings and performance during their earnings calls, which can have an immediate and unpredictable impact on their stock price. Market Expectations Already priced in: Sometimes, expectations of strong or weak earnings are already priced into the stock by the time the announcement is made. This can lead to a “sell the news” response, where the stock moves opposite to what one might expect from the earnings outcome. Analyst expectations: The market’s reaction can be more about how the actual earnings compare to analyst expectations rather than the earnings themselves. Options Spreads Spread and Slippage: Around any meaningful announcement that can move the underlying stock sharply, the bid-ask spread in the options can widen, leading to higher trading costs and potential slippage. So be sure to be cautious, and preferably use limit orders. In some cases though, the options market is not anticipating particularly sharp moves, and this may present an opportunity. Consider Fiserv (FI) . At the moment the options market is implying it is likely to move about 3.5% higher or lower after the earnings report, which is consistent with the long-term average move of 3.2%. Fiserv rallied 5.3% after they reported most recently on October 24th. Adjusted EPS represented a 3 cents a share earnings beat. The past 8 reported quarters have demonstrated solid revenue growth and, other than first quarter of last year, that growth has translated to meaningful year-over-year EPS growth for shareholders. Of course, the stock has rallied pretty sharply since their most recent quarterly results, but options premiums, particularly longer-dated options premia, have fallen. ‘The poor man’s buy-write’ Consequently, this name may set up well for what is sometimes called “the poor man’s buy-write” where one buys longer-dated calls and writes nearer-dated calls against them to offset the decay or “theta.” The trade: Sold Feb. $150 Call $1.15 (Feb. 9 weekly expiration) Bought June $145 call for $8.70 Fiserv provides e-commerce services including transaction processing, electronic bill payment, point-of-sale solutions, check clearing and imaging and works with merchants and financial institutions around the world, although they operate primarily in the United States which accounted for 85% of the company’s revenues in the most recently reported full fiscal year. The idea here is that once the weekly Feb. 9 $150 calls expire we can then write additional call options (or even put options, thus creating a bullish “risk reversal”) against them to continue to collect premium over time. DISCLOSURES: THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
This story originally appeared on CNBC
