A Low-Risk Earnings Play for May

One of the main advantages of buying options is absolute financial risk.  The potential for gain is unlimited, but long option buyers can rest easy with the knowledge that the worst that can happen is the premium going to zero.  

Unfortunate, but not a catastrophic losing situation…

This quarter of corporate profits is nearly complete with over 60% of the S&P 500 exceeding expectations.  A few weeks remain as the information tails off until the next data is released after the July 4th holiday.  
Earnings Strangle

An earnings announcement surprise can be the catalyst for a large directional stock breakout either up or down.  The option Straddle strategy of buying both a Call and a Put in advance of the data release positions for a significant price move.

A twist is to buy more time until expiration than is needed for the specific event so that the exit of the losing side can salvage decent premium.  Then the option in the breakout direction can be managed to maximize the follow through price trend.

After Earnings Breakout – Drop the Loser and Ride the Winner…

If the numbers are a non-event, close out the whole play with a minimal loss of time value. The option will still have solid value since there’s still 45 days until expiration. The time decay will be minimal for the deferred option months in comparison to the front month gamble for all or nothing winnings.  

COSTCO is a Go with Earnings May 24th

Typically, options become more expensive as the earnings release approaches and buyers get more fearful of a surprise.  To avoid much of the increase in volatility enter into the Strangle or Straddle as soon as possible.

Because Costco is not trading at an even dollar number the tactic to buy calls and puts one strike higher and one strike lower is optimal.

With the stock at $83.50 this means an $85 call and the $82.5 put.  The combined cost of the two options to play both directions is less than $500.

The Options Way: Unlimited Upside Potential with Limited Risk

The COST long call and put options can provide the staying power in a potential larger trend extension.  More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.

Choosing an option can sometimes be a daunting task with all of the choices and expirations.  Simply put, traders want to buy a high probability option that have enough time to be right.

The option strike price is the level at which you have the right to buy without any obligation to do so.  In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for gain or loss.   

There are two rules Straddle traders need to follow to be successful.

Rule One:  Play both sides with just out to the money options.  The total cost of the Straddle (Call and Put) need to be less than 10% of the value of the stock   The more expensive the play in relative terms compared to the stock the larger move required to be profitable.      
Rule Two: Buy more time until expiration than you may need, at least two months for the trade to develop.  Time is an investor’s greatest asset when you have completely limited the exposure risks.  

Traders often buy too little time for the trade to achieve profitable results.  Nothing is more frustrating than being right but only after the option has expired premature to the desired move.

Trade Setup:  With Costco at $83.50 the earnings play recommendation is to BUY the July COST $85 Call and $82.50 Put at $5.00 or less.   After earnings, exit the option opposite the breakout move and manage the trend with the winner.

The maximum loss is limited to the $500 or less paid per Straddle position. The upside, on the other hand, is unlimited.

The expiration COST option trade breakevens are $90 on the upside ($85 strike plus $5.00 total option premium) and $77.50 on the downside ($82.50 strike minus $5.00 total option premium.  

These thresholds are only 6% above and below the current share price with earnings data a possible catalyst for a multi-month breakout trend.