Maybe that statement is too harsh, but I spent a good amount of time typing a great post on how to play around an earnings announcement. Sure enough, when the computer froze, said post was lost forever. Can you recall a time when that has happened to you? It felt like I lost a part of my soul. Yes, my words were that good.

I'll try again, but now I am not nearly as motivated. I am leaving in a few hours to Southern Utah/Las Vegas to play 72 holes of golf. It has been about three weeks since I last played, hence the lack of posts on trading & golf. So I will be quick and to the point....

Did anyone else have a trade on RIMM today? I received a few e-mails of people that held on to their calls (Lucky, lucky...) or had a straddle or strangle. I had a few others that had trades prior to earnings, wanted to stay in, didn't... and bailed out. This morning they are probably still in bed, and will not likely think of anything else today other than the opportunity that was missed. Emotion does that to you.

Let's put ourselves in the shoes of a situation where we own a call option. Simple? Just wait. Now we realize that an earnings announcement is next week. The trade is doing well, the company is great, the trend is awesome, and from a technical perspective there would be no visible reason to exit. THE PROBLEM IS....We don't know how the market will react to earnings. I mentioned earlier this week that you might not want this type of ambiguity in a trade. However, if...YOU UNDERSTAND THE RISKS INVOLVED...Do whatever you want! You are the boss. If you want to hold a call over earnings, knowing well that the stock could rapidly and substantially move against you, if you are positioned appropriately and want to take the risk, take it! All you can lose is YOUR money!

What if you want to protect this position from a substantial loss? Let's say that your $50 call on ABC that you bought for $2 is trading at $6 right now. Assume the stock is at $58 per share. Earnings are coming up, what can you do to protect this trade???

Buy a put.

Let's say I buy a $55 put (OTM) for $1. Cheap insurance? Your profit in this trade right now sits at $5 instead of $6, since you paid $1 for the put. On earnings, if the stock gaps higher, you will likely lose the $1 you paid on the put, but made up for the loss in profit on the call. If the stock gapped $5, your profit in the option might now be $11, but you lost $1 on the put. Total Gain= $10.

What if the stock gapped down the same amount? Your call may be trading around the price you paid ($2) but the price of the put should have gained to about $4 or $5 dollars. If your call lost $4 of it's profit, but you gained it back in the put...you are still staring at a $6 gain, which is where you were in the first place. No harm no foul!

Understand that these values are conceptual, not practical. Prices will vary, movements will vary, valuations will vary. Understand that there are variables involved. But hopefully you can see that if you are a trend trader rather than a swing trader, you will need to work through earnings announcements. This can be a great way to protect profits and hedge this event. This is essentially the protective put strategy against a call. The same can be done if you own a put...but an OTM call to protect yourself. It is cheap insurance. Many traders leg into a strangle such as this (appropriate term for this example) and you can see how it may offer protection.

I am heading towards the door, you all have a great weekend. I will not be in the office Monday, but I may post anyway. What a dedicated individual I am.

Posted by Option Addict on 9/29/2006 at 2:12 PM | Permalink