Never sell a covered call option or a cash-secured put for a stock with an upcoming earnings report. This is one of the most important rules in the BCI methodology. As a matter of fact, most other principles I refer to as guidelines because there is some leeway or flexibility to them. For example, the 20%/10% guidelines allow us to veer slightly from those specific numbers.
First perspective: Gap-downs
The most obvious reason for avoiding these quarterly publications is that a disappointing report can result in a dramatic decline or gap-down in share value wiping out the option credit and potentially much more. We must avoid this risk. The good news is that we know the date of the report and so we can maneuver around them in various ways and thus totally eliminate earnings report risk…problem solved. Earnings dates are highlighted in our Premium Member Stock Reports as shown in the screenshot below:
The red arrow points to the column with earnings dates and the gold rows highlight those stocks that report in the current contract month.
A second perspective- Gap-ups
Just as reports can disappoint resulting in a gap-down, they can positively surprise culminating in a gap-up. On 8/11/2016, Acacia Communications Inc. (ACIA) reported earnings after the bell and the after-market price took off like a rocket ship from $70.00 per share to nearly $94.00 per share where it closed the next day. The chart below reflects the gap-up in the yellow field:
Most of the time we will not own shares until after earnings reports pass. There are times, however, when we have a lot of confidence in a stock and decide to keep it despite the report. As an example, MKSI had 16 consecutive quarters of “earnings beats” as of February, 2017. I used to own shares through earnings releases with CSCO and AAPL years ago when those companies always muted guidance resulting in positive earnings surprises. If we do take this approach, it still is in our best interest to avoid selling the options until the reports pass. In the case of ACIA, we could have benefitted by the $24.00 gap-up and then written the call after the report passed and price settled down.
Avoiding earnings reports when selling call or put options is a critical rule from two perspectives. By not owning the stock, we circumvent the risk of a gap-down resulting from a negative surprise. Secondly, if we do decide to own the shares through the report, we can benefit from a gap-up in price caused by a positive surprise.
***My thanks to Joan K. for inspiring this article.
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American Association of Individual Investors
November 3rd – November 5th, 2017
Global stocks continued gains this week as reflationary hopes were rekindled by President Trump’s discussion of US tax cuts. Oil prices were steady with West Texas Intermediate crude holding at $54.10 per barrel. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX) fell to 10.85 from 11.15 last week. This week’s reports and international news of importance:
- Greece faces a deadline to receive much-needed bailout funds from its international backers, but so far it has not fulfilled the terms of its prior commitments. Greece hopes to strike a deal at the last EU summit before the European election calendar kicks off in March. The IMF called Greece’s debt burden unsustainable and called for debt forgiveness
- Populist French presidential candidate Marine Le Pen formally kicked off her campaign this week, laying out her economic agenda. Le Pen called for pulling France out of the eurozone, reintroducing the franc and drastically curbing immigration
- Having peaked in 2015 at over $4 trillion, China’s foreign exchange reserves slipped below $3 trillion in January. Beijing has been selling down reserve assets for the past 18 months to try to stem capital outflows from the Chinese mainland
- The UK House of Commons voted on Wednesday to allow the government to begin negotiations with the European Union
- A US federal judge upheld the legality of the US Department of Labor’s fiduciary rule on Wednesday. The rule, scheduled to go into effect on 10 April, would require financial advisors to act in their clients’ best interest when advising them about retirement accounts. Critics say the rule will limit consumer choice and make giving advice too costly
- German finance minister Wolfgang Schaüble acknowledged that the euro’s exchange rate with the US dollar is too low for Germany’s competitive condition but said that the European Central Bank must make policy for all of Europe, not just Germany. Tensions were inflamed both inside and outside the eurozone as Germany posted a record annual trade surplus. Donald Trump’s principal trade advisor commented recently that Germany has been manipulating the euro exchange rate in order to gain competitive advantage.
- US president Donald Trump spoke by phone for the first time with Chinese president Xi Jinping and reaffirmed the US commitment to the One China policy President Trump also met with Japanese prime minister Shinzo Abe at the White House later on Friday
- As of 7 February, Thomson Reuters reports that fourth-quarter earnings for the S&P 500 Index are expected to increase 8.2% from the fourth quarter of 2015. Of the 300 companies in the S&P 500 that have reported to date for the fourth quarter of 2016, 68% have reported earnings above analyst expectations
- The Q4 2016 blended revenue growth estimate is 4.3%
- The forward four-quarter (1Q17– 4Q17) P/E ratio for the S&P 500 is 17.4
THE WEEK AHEAD
MONDAY, February 13th
- None scheduled
TUESDAY, February 14th
- Producer price index
- Janet Yellen testimony
WEDNESDAY, FEB. 15th
- Consumer price index
- Core CPI
- Retail sales
- Industrial production
- Home builders’ index
THURSDAY, FEB. 16th
- Weekly jobless claims
- Housing starts
- Building permits
FRIDAY, FEB. 17th
- Leading economic indicators
For the week, the S&P 500 was up by 0.81% for a year-to-date return of 3.45%.
IBD: Market in confirmed uptrend
GMI: 5/6- Buy signal since market close of November 10, 2016
BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. I was encouraged with the positive earnings surprises that have dominated this earnings season.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a neutral to slightly bullish outlook. In the past six months, the S&P 500 was up 6% while the VIX (10.85) declined by 10%.
Wishing you the best in investing,
Alan ([email protected]) and the BCI team