So many times I have heard traders say they do not hold stock through earnings reports. They are afraid of the volatility that the singularity can create. And on the surface it makes sense, when you see a stock drop 20% after reporting good earnings and upside guidance going forward, but it just does not meet what analysts expected. Why should you be exposed to that?
Well, for one thing, you liked the stock the day before for whatever reason. If you are purely a day trader than I can accept this position. But for everyone else there are better alternatives than giving up the potential upside that you saw when you entered the trade or position. In fact, this is exactly what the options market was designed for.
Walt Disney, $DIS, reports earnings after the close tonight (Tuesday), and I hold positions for myself and clients. Let’s look at this as a practical example of how to protect your position, using the chart and the options open interest.
The chart above shows that Disney has been in an uptrend and revisited that trend finding support last week. it also shows an area from 82.50 to 83.50 below that where there has been support in the past. This happens to also sit at the 100 day SMA. That is over 4.5% below the current price. Disney is a low volatility stock that moves less than 2% on earnings reports historically. So a 4.5% move would be big. Protecting to the 82.50 area may be excessive but looks to cover a big move.
The options market can be viewed simply in the screen capture above. it shows the activity for the August 8 Expiry contracts with strikes between 80 and 92, or about $6 each side of the current price. First from the the at-the-money straddle (average of 86 and 87) the options market is expecting a move of about $2.45 this week. This makes a range of about 84 to 89 from the current price. Next, the open interest (OI) shows big volume at the 89 and 90 Strike on the call Side, both overwhelming the OI at 85 on the Put side. This shows that existing protection and positioning favors the upside and see the stock staying below 90 this week.
With just this simple information you can now protect your position. A simple way is to buy the August 8 Expiry 86/83 Put Spread (offered at 76 cents in this chart). But if even that 0.88% cost is too expensive at you can also sell a covered call at the 89 Strike (41 cents) or 90 Strike (23 cents) to cut the cost by 25-50%. Tactically if the stock drops then you would sell the put spread for a gain and reassess if you want to own the stock still. If it rises to 90 or higher then you can buy back the covered call or roll it higher, or accept the gain and let the stock get called away. None of these options involve a loss of more than the premium paid for protection, until the stock drops below 83.
So sell your stock because of earnings or pay 35 cents to protect it and continue your trade. Which will it be?
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