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Earnings Season Can Be Bountiful With Options Trading

Earnings season is in full swing, with a third of S&P stocks scheduled to report this week. If the S&P 500 is any indicator of how companies performed during the first half of the year, stock investing continues to be one of the best ways to line your financial coffers.

That being said, there are plenty of ways to play the market during earnings season, and one of those is through buying options. For this blog, I’ll keep it simple. I won’t go in to the various, complicated strategies that very experienced traders, and those with high tolerances for risks will use.

Instead, I’ll lay out the basics of options trading so you can decide if earnings season is a good time to play the options market.

 · What Options Entail

Before tackling how to play the market during earnings season using option strategies, let’s be clear on what they entail.

As defined by Nasdaq.com, options are contracts through which a seller gives a buyer the right, but not the obligation, to buy or sell a specified number of shares at a predetermined price within a set time period. Because they are considered to be derivative products, their value comes from the value of an underlying investment, which usually is the stock of the company.


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Here are some main terms you’ll hear when talking about options: call and put contracts, strike prices, expiration dates.

While call options allow the buyer to purchase a stock at a set price on or before a determined date, put options allow the buyer to sell a stock on or before a later date. That determined date is referred to as the expiration date. It is typically the Saturday following the third Friday of the expiration month. Expiration dates can also fall at the end of the quarter.

Exercising the option means you buy or sell the stock via the option contract. The strike price refers to the price at which the options contract can be executed. In the case of call options, the strike price is the amount the option can be bought any day leading to the expiration date. For put contracts, the strike price is the price it can be sold.

The last day to trade options before they expire is the Friday before expiration, or the third Friday of the month. This is also generally the last day an investor may notify his brokerage firm of his intent to exercise an expiring equity call or put, notes Investor Place. The website also notes that brokerage firms, can set earlier deadlines for notification of an option buyer’s intention to exercise. “Therefore, you should check with your brokerage firm about its procedures and deadlines for instruction to exercise any equity options. If Friday is a holiday, the last trading day will be the preceding Thursday,” states Investor Place.

 · Show Me the Money

A key element of options trading deals with the strike price, which can help you determine the best time to buy or sell an option.

When the strike price is the same as, or is close to, the price of the underlying stock, it is considered to be at the money. If that strike price is less than the price of the underlying stock, it is in the money. And if it is above the price of the underlying stock, it is out of the money.

 · Open Interest

During earnings season, one of the ways I look at options is to gauge where other investors and traders think a stock will move. That may entail the stock climbing as it’s believed the company will beat analysts’ estimates. It could also entail the stock moving lower if it’s believed the company will miss its earning’s estimates.

More open interest is better because it tends to mean there is more liquidity for the call option you are trading, according to BornToSell.com. It notes that more liquidity means smaller spreads between the bid and ask , which is good for the trader if they need to close out a position before the expiration date.

To get an idea of what direction investors think a stock will move, I look at the amount of open interest there is in that company’s options. It is imperative the option traders understand open interest; doing so can help you to see how much liquidity there is in an option. You want that option to be liquid so that you can essentially sell it if the trade goes against you. Options that have no open interest als have no secondary market. On that same note, options that have a lot of open interest means just that – there are many interested sellers and buyers. Furthermore, there is likelihood that orders for that option will reap good prices! That will make it easier to trade the option, with a spread between the bid and ask that you may be able live with.

 · Ideas

Let’s look at some of the companies that have reported, and who are reported earnings this week. More specifically, we’ll look at those that have option expirations this week, too.

Tesla (NASDAQ: TSLA) on Wednesday reported earnings on Wednesday. Although it reported that its losses triple during the second quarter, and cut the number of deliveries for the rest of the year, options activity indicated traders and investors have some faith in the auto/battery maker.


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Specifically, its $300 call contract that expires on Friday, Aug. 7 had open interest of more than 5,000, This is the most open interest than any of its other call contracts. This means that many watching the stock think it may trade up to $300 a share from roughly $270 a share where it closed Wednesday.

As far as puts, its put contract with a strike price of $235, and also expires Friday had open interest of about 2,100. The thought is that Tesla could sink this low as of Friday.

For equity options expiring prior to Feb. 15, 2015, the expiration date is the Saturday immediately following the third Friday of the expiration month.

For equity options expiring on or after Feb. 15, 2015, the expiration date is the third Friday of the expiration month. The day expiring equity options last trade is the Friday before expiration, or the third Friday of the month. This is also generally the last day an investor may notify his brokerage firm of his intent to exercise an expiring equity call or put. Brokerage firms, however, may set an earlier deadline for notification of an option buyer’s intention to exercise. Check with your brokerage firm about its procedures and deadlines for instruction to exercise any equity options. If Friday is a holiday, the last trading day will be the preceding Thursday.

 · Conclusion

How much you will profit on the transaction depends on whether you’re right. On that same note, how much you will lose depends on how wrong you are. Anything can move a stock price, but it is the near certainty that the price will move during the days following the release of earnings is what makes buying the around this time appealing to many traders.

Some rules of thumb: buying a call typically means you are bullish on the stock; and buying a put means that you are bearish. Open Interest

If you see a lot of call activity, it usually means that traders think the price of a stock will go up by the time the contract expires. On that same note, if you see a lot of activity in put options, it may mean that traders are betting that the stock will trade lower by the time the contract expires.

 





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