Last week, fans of the NFL eagerly watched as their teams drafted their newest members, and when the picks were made, talking heads on TV and fans alike gave instant reactions ranging from delight to horror. I watched none of it, pretty much like I paid zero attention to the months of mock NFL drafts leading up to draft day. Now, everyone is guessing whether the players will be stars or busts! The only thing I hate more than the NFL draft and the draft grades released minutes after the draft is earnings season—another guessing game.
ESPN’s Mel Kiper, Jr. has been recognized for well over 20 years as THE expert on the NFL draft. So how did he do in predicting the first 10 picks in the draft this year? He got 9 out of 10 WRONG!! Thanks for those three months of worthless content and predictions.
Similarly, the general managers who make the picks every year make educated guesses when selecting their team’s next players. But year after year, most of them make bad pick after bad pick. For example, how many quarterbacks were picked ahead of future Hall of Famer Tom Brady back in 2000? Six. And only two of them played in the league for more than a couple of years.
Earnings Season Is Like the Draft
Like the NFL draft, earnings season is mostly an educated guessing game. And that’s the reason I very rarely buy a stock or option positon right before earnings are released. For all any of us know, the company will miss earnings or revenues. Or even worse, the company will exceed analysts’ expectations, and the stock will sell off regardless because the company didn’t beat estimates by enough.
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You’ll note that I said I rarely buy before earnings, not never.
There are, in fact, certain times when I buy a position before earnings—though I am very picky when I do so. What would lead me to buy?
A combination of bullish options order flow and favorable risk/reward.
For example, traders at Cabot Options Trader and Cabot Options Trader Pro bought positions in Oracle (ORCL) and Visa (V) ahead of earnings because I spotted unusual option activity. Day after day this earnings season, I saw traders buying thousands of calls, targeting moves to new highs. And when I evaluated the price of calls, I concluded that the price was just too good to pass up.
Here were the trade alerts I sent to my subscribers before the companies reported earnings:
Buy Oracle (ORCL) June 44 Calls (exp. 6/16/2017) for $1.25 or less.
Oracle popped on my radar yesterday when a trader bought over 20,000 June 44 Calls for $1.11. This follows a late-January buyer of 8,000 January 45 Calls that remain in open interest and a buyer of 4,000 April 44 Calls on Tuesday.
The most you can lose on this position is $125 per call purchased.
I expect to hold this position through earnings, which are expected in mid-March.
To pay $1.25 for a call just $1.10 out-of-the-money with four months until its expiration seems like a great risk/reward.
Buy the Visa (V) June 90 Calls (exp. 6/16) for $2.35 or less.
As I noted last week, Visa (V) has seen steady call buying for the last two weeks. Much of this action has been focused on May 90 Calls, which have seen open interest jump to nearly 30,000 since March 30. The bullish activity continues yesterday and today, as a trader executed the following trades:
Yesterday: Buyer of 5,000 Visa (V) May 90/95 Bull Call Spreads and Sale of May 85 Puts – Stock at 89 (bull risk reversal)
Today: Buyer of 14,000 Visa (V) May 92.5 Calls for $0.84 – Stock at 88.40
The most you can lose on this trade is the premium paid, or $235 per call purchased. And to pay $2.35 for a call is a great risk reward opportunity with the stock just $1 from the strike price.
Both Oracle and V subsequently reported blowout earnings. Cabot traders took profits of 170% on half of the ORCL position and profits of 25% on half the V position before earnings were announced, and continue to hold the remaining half positions.
The Next Earnings Winner?
And I am very excited about our newest earnings season call purchase made last week. A trader has been aggressively buying call options—$9 above the current stock price—that expire in the next couple of weeks. For the trader’s position to be successful would require a huge move higher in the stock on earnings or a takeover/news event. To learn more about this trade, click here to join my Cabot Options Trader advisory.
That said, while I love the setup on this new trade, there’s always the potential that it could fail because earnings season is the great unknown. However, if the signs are there in the options market, and the price of the option is cheap enough to push the risk/reward in our favor, this trade has the potential to be our next Tom Brady.
Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.Learn More