Trading and Holding Through Earnings

• Posted by Greg Harmon
• on January 9th, 2014

I do not know how many times I have seen a trader brag about how they do not hold a stock through earnings…..ever (with emphasis). It really makes me sad to read those posts. Here are some traders that are clearly good at what they do, and that means risk management, that decide to just avoid risk and forgo their trade because of a known event. My friend Josh Brown (@ReformedBroker) jumped into this game earlier this week with these tweets.

Sounds like he is in that camp too and not willing to trade or hold through earnings. I got a lot of notes from people on these tweets. Most trying to start some controversy. Others wondering if I was concerned about this or that. As it turns out I totally agree with Josh. If you are trading the stock of a company that is reporting earnings then you are playing with fire. Yet I do it all the time.

As traders, investors or managers, your job is first to control risk. And for known events, like an earnings report, there are tools you can use to do that. Most times there is no reason to sell a position to avoid the volatility that can occur after an earnings report. Whether you choose stocks based on fundamentals or technicals don’t you want to be able to see your ideas play out for more than 3 months? When I hold a stock for clients or myself that is reporting earnings my first thought is how do I mitigate the risk from the event. Most often the answer is by using options. Options can be used to protect the downside risk of a position for minimal cost and often free. Alcoa is a good example that reports tonight. It is moving out of a long base and may have a long way to go higher. If you hold it now do you really want to sell it? What if it gaps up 20%? There are three main strategies that I use to protect stocks at earnings.

1. Buy Puts.
2. Buy a Put Spread.
3. Buy a Collar.

The first, buying Puts, is also the simplest. Buying Puts costs money but protects your downside. By buying a Put with a strike at or near the current stock price you are protected for any downside from a reaction to the report. The plan is to buy the Put and then sell it after earnings as the stock either turns back higher or the option is about to expire if it is still moving lower.

A Put Spread lowers the cost by capping the downside protection. In this strategy you buy the Put from above but then sell a lower strike Put to reduce the cost. This strike should be chosen at a level that you do not think the stock price will drop below. But it should also be valuable enough to warrant capping the downside. I look for at least 25% of the original Put cost.

A Collar adds a short Call to the Put or Put Spread. You can look at this as a covered call capping your upside. It is usually of a longer expiry than the Puts so that selling it retains some upside and covers the cost of the Put.

These strategies to protect stock through earnings are not complicated and make a lot of sense if your idea is still playing out. We employ them constantly for our clients. Shouldn’t you?

I happen to know that Josh’s aversion to trading or playing stock through earnings is specific to trading short term stock without any protection for the event. He is an investor who sometimes trades, not a trader, who will hold most positions through earnings and will almost never make a sale because of a coming earnings report. Managing risk and protecting positions is different than trading it unprotected specifically for an event.

_Get my book, Trading Options: Using Technical Analysis to Design Winning Options Trades.
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