Then I learned a great lesson about Best Buy and earnings. Despite the size of this company, it tends to whip around on and after earnings.
Over the last few earning cycles the stock has had a tendency to move about 5%-10% close to open on earnings. This is regardless of where the stock is trading.
However, that is not the end of the story. Best Buy, more than most stocks, does not stop moving after earnings. More often not, the stock continues to trend in the direction it opens. When it has opened down, it has continued down. When it has opened up, it has continued up. In some cases, the price action after the initial gap is far greater than the gap itself.
If we throw out the last earning cycle (always a dangerous proposition), BBY has a tendency to keep moving after its earnings gap. Sometimes the movement involves Best Buy taking off for the rest of the day. On other occasions, it involves a general trend in which the stock rallies for the next few days or even weeks.
Best Buy reports earnings June 15, so how can a trader use this knowledge to his or her advantage?
BBY Earnings Trade
Even as a pro, I find myself dumping before the underlying moves or implied volatility (IV) rallies. It is fun to play these straddles, but overall, most retail traders tend to get shaken out of earnings straddles fairly quickly.
I would argue there is an easier way to play Best Buy: a "surgical strike" option trade. In other words, buy the trend after earnings. Typically, the trader will have a good opportunity to buy the options (even with the wider spread) shortly after the open.
As a bonus, especially on up moves, there tends to be an over crunching of volatility in the first few minutes before IVs settle into their normal levels. If the trader can scoop the options while this crunching is going on, there may actually be even more opportunity to profit if the trend continues than just simple price action.
I would warn that this is not a long-term trade. I like the trade for a day or even a few hours. Generally, these trades end in a wash if held for an extended period of time. The surgical strike is only for those who are able to watch the open, and monitor movement. Traders make a gain and exit.
Another warning on this strategy, execution is very important. Trying to squeeze 3 cents from the option spread on either the entry or exit is probably not worth the fight.
Finally, practice this strategy before trying to execute it live. Before I started playing earnings, I had months and months of training at the hands of the market makers that showed me the ropes of the derivative world.
Trading an earnings play is an inherently difficult thing to do. While I argue that options are not a zero-sum game, playing earnings may be the closest example of when options are, in fact, a zero sum. But, with practice, traders can learn to use the scalpel that is their trading platforms, because sometimes it takes a surgical knife and not a meat clever to succeed.
by Mark Sebastian, Option911 06/04/10
No comments:
Post a Comment