Monday, I noted that: “The latest episode of CNBC’s Options Action featured a trade recommendation on Google (GOOG). With shares just below $470, the guest recommends a July 470 – 500 call spread at $7.50. In other words, they think it’s a good time to buy July 470 calls at $9.70 while selling July 500 calls at $2.20. It’s an earnings play, because Google reports Thursday and the July options come off the board Friday. So, after the company reports, the options will have one day of life remaining.”
I wanted to track this trade and see how well it worked. The graphic below shows the prices for the spread Friday before the show aired. Monday, GOOG opened higher and it would have been impossible to get filled at $7.50, which is a good thing.
As I noted Monday, the “problem with this type of trade is that it’s success depends on the earnings announcement. A positive report will send the stock higher. A miss will probably send the stock lower. It’s a crapshoot. And, if the stock fails to move beyond $470, the entire debit is at risk. The potential pay-off (excluding commissions) is the difference between the two strikes minus the debit, or $22.50.”
Google is down to $467 Friday morning after missing on earnings. The spread is trading around $1.25. If held to the close, it’s very likely to result in a 100 percent loss.
The lesson here: don’t trade around earnings. I’ve done it, experimented with a number of different approaches — strangles, buying only puts, only calls, etc — and it’s extremely difficult to trade profitably around earnings releases. There are too many variables and the result is often similar to a coin toss — heads you win, tails you lose.
When trading options, it’s much better to focus on strategies that have better odds of success like buy-writes, flys and condors, timespreads, or vertical spreads on stocks that have clearly bullish or bearish fundamentals/technicals. We provide a steady stream of updates that focus on these kind of “smart money” trades that can be used as a starting point to finding good opportunities. We also post a Trade of the Day to highlight some of the best ideas to make you money. A vertical spread around an earnings release will definitely not be one of them.
Category: Trading Education
About the Author (Author Profile)
Frederic Ruffy is a well-known trader, writer, and strategist who has spent years educating investors and creating intelligent, insightful, unbiased market observations that are frequently cited by the Wall Street Journal and other financial publications. As senior analyst, Fred provides frequent and regular notes and daily updates for activity of interest.