Corporate announcements on quarterly results are around the corner and it is one of those times that create volatility in the market. The challenge with events like this, is that it is very difficult to take a directional bet. The volatility can take a very ugly turn if we were expecting a bullish move and the stock tanks 20 percent.
To tackle results, we need a trade option that has defined limited risk. This helps when in a bullish trade. Thus, even if the stock tanks 40 percent after result, all we have to lose is the premium.
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Most of us have a decent grip on trading options. We know if we want to place a bullish bet we should buy a Call option and for bearish bet we should buy a Put option. However, when a stock goes through results, the behaviour of Option premium slightly changes. If we accommodate for the same, Options can make trading during this excessive volatility (risk) very easy and comfortable.
What are the difficulties in trading Options during results?
Options are priced accounting for the risk of volatility in the stock. More volatility stock will have more expensive Options.
Consider 2 stocks:
Stock A @ 100 has 52 weeks High = 150, 52 Week Low = 70 (Capable of huge volatility)
Stock B @ 100 has 52 weeks High = 110, 52 Week Low = 90 (Capable of low volatility)
Call option for same 100 strike for Stock A could be trading at 3 and same expiry 100 Call option on stock B could be trading at 1 just because Stock A is expected to be more volatile.
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It is similar during earnings season. Every stock that is pricing Options like stock B in normal times is capable of higher volatility during results and starts behaving like Stock A.
So, ahead of Results 100 CE = 3
Without any change after results normalcy returns, so Options starts behaving normal (like Stock B), and the same 100 CE even without any price change, drops down to 1.
How to handle this?
You can handle this in two simple ways. As follows:
1. When trading Options create a Spread: This means for Bullish Trade Buy a Higher Strike Call and Sell 2-3 strike Even Higher Strike Call. And for Bearish Trade, Buy a Lower Strike Put and Sell 2-3 strike Even Lower Strike Put.
Unlike simple Option Buy this will restrict the profit to difference between sold and bought strikes. Also, there will be margin involved but it still proves better off. Reason, remember we will be Buying when premiums are high like Stock A and booking profit after results when premiums are low like stock B.
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2. Evaluate and adapt after result announcement: Once results are out, it is clear within 15-20 minutes if our bullish/bearish bet is right. If wrong, cut the losses (which will be low due to spread). If correct, remember the result related volatility expectation would have now gone down. Book profits and create a new trade if more upside is expected.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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