Trading strategies for corporate earnings

Earnings season can be an exciting time of year for traders who look forward to the release of financial reports from publicly traded companies and their subsequent stock market movements. When companies release earnings, stock prices will often react with elevated volume, volatility and price action.

This “season” refers to the months when quarterly (or yearly) earnings reports are released. Most companies release reports based on the start of calendar quarters, being January, April, July and October. However, not every company’s fiscal year will match up with the calendar year.

For example, some companies will consider September to be their “fiscal end of year”.

If you’re planning on making any trading or investment decisions, it’s always important to do your research ahead of time. This is especially so for earnings season when it’s common for individual stocks to experience high volatility, large price swings or even “gaps” up/down in price.

To compound the issue, many of these price movements occur during pre and post-market trading hours. Most companies announce earnings in the morning before markets open (9:30am ET), or right after markets close (4pm ET).

To do your “due diligence”, it’s important to consult a variety of data sources such as:

• Analyst forecasts and reports
• Earnings guidance (estimates)
• Investor news and media
• Earnings/conference calls

We offer several tools and data sources to help you make more informed trading decisions, most of which are built right into the trading platform of your choice.

Explore tools such as Analyst ratings,  News analysis, the Smart score and more on our Research pages. You can also view relevant news by company/ticker symbol on the quotes pages.

When preparing for an earnings report’s release, it’s important to manage both your expectations and that of the overall market.

It’s common for a company to meet, or even slightly exceed their earnings targets, but due to the market’s high expectations or poor forward guidance, this can still lead to a decline in share price.

On the flip side, there are many instances of companies failing to meet forecasts and earnings targets, but due to overall market sentiment or positive forward guidance, the price can remain “flat”, or even rise on occasion.

Make sure to always consider the overall market outlook or sentiment when analyzing potential future price moves around earnings reports.

Lastly, before learning more about the strategies below, it’s important to understand which outlook you take on the stock’s future performance.

If you expect the stock’s price per share to increase following an earnings report, you’re considered to be bullish.

You can potentially consider the following example strategies organized by complexity, and risk level:

1. Buy the stock before the earnings report.
   • If you’re correct, and the shares increase in price, you can sell them for a profit following the earnings report, or hold them to sell in the future.
2. Buy (long) a Call option with an expiry date after the earnings report.
   • Call options give you the right (but not the obligation) to purchase 100 shares per contract of the underlying security at the strike price.
   • If the stock’s price rises (or volatility increases) , you can either sell it back into the market for a profit, or exercise your contract if desired.
   • Learn more about Long Calls in this article.
3. Sell a Covered Call (if you already own at least 100 shares), or participate in a buy-write strategy.
   • Covered calls may provide extra income in the form of a premium, however you risk having your shares being “called away” if the share price increases above the strike price by the expiration date.
   • Learn more about Covered Calls in this article.
   • A buy-write strategy is when you purchase 100 shares of a stock at the same time as selling (writing) a call option against the same underlying stock.

The three strategies explained above are available in all accounts, including registered accounts like TFSAs or RRSPs. Remember, to trade options, you need to have them enabled in your account.

If you’re trading with a Margin account, the more advanced options strategies below are also available if you’re bullish on a stock before earnings:

1. (Bullish) Vertical call spread
2. (Bullish) Vertical put spread

For more advanced traders, Questrade offers multi-leg option trading in all of our Edge platforms, giving you easy access to order entry for multiple calls, puts or shares.

Note: Transactions in options can carry a high degree of risk, and may not be suitable for investors with a limited risk profile.

Purchasers and sellers of options should familiarize themselves with the type of option (i.e. put or call) they contemplate trading and the associated risks.

Before diving into options strategies, make sure to learn the basics of how options trading works.

Essentially, the closer it is to an earnings release, the greater the potential implied volatility will be (due to the potential for price swings). Right after an earnings release and subsequent price action, implied volatility will generally drop back down to the historical average. This decrease is often referred to as volatility crush.

This generally makes options contracts more expensive closer to a company’s earnings release, which can significantly affect your strategy whether you’re buying or selling options. 

If you expect the stock’s price per share to decrease following an earnings report, you’re considered to be bearish.

Explore the following potential strategies organized by complexity, and risk level:

1. Buy (long) a Put option with an expiry date after the earnings report.
   • Put options give you the right (but not the obligation) to sell 100 shares per contract of the underlying security at the strike price.
   • If the stock’s price falls, you can either sell your put back into the market for a potential profit, or exercise your contract*.

     *You can only exercise a put in a registered account if you already own 100 shares of the underlying.

   • Learn more about Long Puts in this article.
2. If you already own the stock, you can buy a Put option to create a Married Put strategy.
   • This allows you to hedge (protect) your position if prices drop, and sets your maximum loss.
   • If the stock’s price falls below the strike price of your put option, you can exercise your contract(s) to sell your shares at the strike price.
   • This acts as a form of “insurance” and allows you to set a price “floor” for your holdings that you can sell at before expiration.
   • Learn more about Married Puts in this article.

The two strategies explained above are available in all accounts, including registered accounts like TFSAs or RRSPs. Remember, to trade options, you need to have them enabled in your account.

If you’re trading with a Margin account, the more advanced options strategies below are also available if you’re bearish on a stock before earnings:

1. Short (sell) the stock before an earnings report.
   • If the price per share decreases following the earnings report, you’re able to buy back the shares at a lower price to earn a profit off the decline.
   • When you short sell, you create an immediate credit in your account, but you’re required to maintain the minimum margin requirements of the position.
   • Learn more about Short-selling stocks in this article.
   • Note: Short-selling can expose you to theoretically unlimited risk if the price per share increases. Strongly consider hedging a short position with options, or pre-defined exit points for your trade.
2. (Bearish) Vertical call spreads
3. (Bearish) Vertical put spreads

For more advanced traders, Questrade offers multi-leg option trading in all of our Edge platforms, giving you easy access to order entry for multiple calls, puts or shares.

Note: Transactions in options can carry a high degree of risk, and may not be suitable for investors with a limited risk profile.

Purchasers and sellers of options should familiarize themselves with the type of option (i.e. put or call) they contemplate trading and the associated risks.

Before diving into options strategies, make sure to learn the basics of how options trading works.

If you expect the stock’s price to mostly stay the same after earnings, you can also consider some of the neutral strategies described below.

Explore the following potential strategies organized by complexity, and risk level:

1. Sell a Covered call (if you already own at least 100 shares of the underlying stock.)
   • If you don’t expect the stock price to rise or fall after earnings, a covered call can be a strategy to make a little extra income in the form of the options premium earned.
   • Covered calls can be bullish to neutral, but regardless of the stock’s price action, you can always count on the premium for the contract(s) sold.
   • If the stock’s price rises above the strike price of your call option, your shares will be assigned (called away), however you’ll still make the capital gain on the difference between your average purchase price and the strike price of the call option you sold.
   • Learn more about Covered Calls in this article.

Explore the external links and resources below to learn more about these advanced strategies:

• Short straddle
• Short strangle
• Iron condor
• Butterfly spread

Note: Please note that any hyperlinks on this website are provided for informational purposes only and do not necessarily reflect the views or opinions of Questrade, nor are they responsible for their content or accuracy.

So you’ve learned the ins and outs of earnings and with some example strategies now in mind, want to start trading during this exciting time of year? We’re here to help provide you with a short checklist to make sure you’re ready to get in on the action.

• Check what date and time the company is announcing earnings to help plan your trading decisions.
• Explore the stock’s historical price action around earnings. Does it rise when forecasts are beat? Does it fall when anticipated revenue misses? Past performance is never a guaranteed indicator for future price movements, but historical data can help provide more data points to help decide if you’re bullish, bearish or neutral.
• What are the different analysts saying ahead of earnings? What has the company themselves stated in their earnings forecasts or guidance?
• Are there any external market factors that might negatively or positively affect earnings, such as interest rate announcements or GDP reports?
• Make sure you understand important terms like EPS or P/E ratios, you can learn more about these in our article on corporate earnings and guidance.
• Decide if your trading strategy is bullish, bearish, or neutral, then plan your anticipated trades in advance.

Please be advised that the strategies discussed above may not be suitable for all investors depending on your personal risk tolerance, and familiarity with options contracts.

This article does not disclose all of the risks and other significant aspects of trading in options. In light of the risks, you should undertake such transactions only if you understand the nature of the contracts (and contractual relationships) into which you are entering and the extent of your exposure to risk.

Trading in options is not suitable for many members of the public. You should carefully consider whether trading is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances. Transactions in Options carry a high degree of risk. Purchasers and sellers of Options should familiarize themselves with the type of Option (i.e. put or call) which they contemplate trading and the associated risks. For more information, please refer to our complete Options Risk disclosure.

Note: The information in this blog is for educational purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade, Inc., its affiliates or any other person to its accuracy.