If you watch the financial news media, you've seen how earnings releases work. It's like the big game on Sunday; it comes with hours, and sometimes days, of endless experts providing their predictions of what the numbers will look like, and other experts providing their strategies of how to invest or trade based on the news. Some would say that it is media overhype at its finest and if you watch the endless flurry of graphics and "earnings central" music, it's hard to argue.
But for the individual investor, is there money to be made in earnings announcements? As with most topics on Wall Street, there are a flurry of opinions, and it will ultimately come down to individual choice, but here are two of those opinions to help you decide for yourself.
Profit From Earnings Surprises With Straddles And Strangles
Why You Should Try
According to CNBC, the percentage of
S&P 500 companies that beat their earnings forecast in the first quarter of 2012 was over 70% and according to the Bespoke Investment Group, the average one day change to these stocks was 0.47%.
Taking a risk to gain only one half of one percent may not seem worth the time, especially after short term capital gains taxes are subtracted, but investors know that the average stock isn't the type of stock they're after. Instead, they're looking for a stock like Apple that rose $50 the day after they reported blowout earnings. This represented nearly a 9% gain from the day before.
But Apple is hardly the most impressive; 17 companies saw gains of more than 15% the trading day after their earnings announcements. Notable companies like Amazon rose 15.77%, Cirrus Logic rose 18.62% and Expedia rose 26.53%.
If a trader could lock a payday like Apple, or one of the 17 companies that added sometimes as much as 25% to their stock price, it seems that the odds would be in the favor of the investor, since seven out of every 10 S&P stocks beat their earnings forecast.
SEE: Earnings Power Drives Stocks
Why You Shouldn't Try
The reality is much different. First, for every one of those big gains, there are stocks that suffer big losses.
Riverbed Technology saw a loss of 28.75% of its market value and Allscripts-Misys lost more than 35% since January, but even those catastrophic losses aren't why many investors choose to stay away from earnings announcements. Just because a company releases a positive earnings announcement doesn't mean that its stock will rise. Every trader can tell stories of big losses on the back of what seemed to be an impressive earnings release.
The other problem is the inability to forecast the release. Other than listening to the analyst community, there is no educated way to forecast the report or how investors will react. Good traders know that trading is largely about managing risk and that's hard to do when trading around one event.
For those who wish to trade earnings announcements, the best strategy is to not try to make it an all or nothing endeavor. Don't look for the big score, but instead look to get a piece of the gains, so that if the trade doesn't go your way, you're also only incurring a piece of the loss.
For example, if you're trading the release with options, use an advanced strategy like a spread,
straddle or strangle, instead of buying only a call or put contract. For stocks, use a pairs trading strategy or hedge with a put option.
SEE: Strategies For Quarterly Earnings Season
The Bottom Line
Many traders believe that trading around earnings announcements doesn't provide an attractive risk/reward proposition. In order to make it more attractive, advanced trading techniques, often outside of the skill level of the beginning investor, have to be employed. Veteran traders know that trying to set up for the big one-day jackpot rarely works in their favor over the long term.