Make Money Next Week Whether This Stock Soars or Tanks
Third-quarter earnings season is almost finished, but one economic bellwether, FedEx (NYSE: FDX), has yet to report. The stock has traded in a $10 range for the past six months, but an earnings surprise next week could have a major impact on the stock price. The question is, which direction will it go?
Rather than trying to guess whether FedEx will exceed expectations or disappoint, traders can use an option strategy known as a strangle. An options strangle involves buying an out-of-the-money call and an out-of-the-money put with the same expiration date.
Because volatility is low with new multi-year stock market highs being made, option-buying strategies are less expensive in relative terms than they have been in a long time. By buying both a call and a put, you can set yourself up to profit from a large movement in the stock in either direction. After the earnings breakout, you simply sell the losing option and ride the winner.
A twist is to buy more time until expiration than is needed for the specific event so that when you exit the losing side you can salvage a decent premium. This also allows you to manage the option in the breakout direction to maximize the follow through price trend.
If a major move fails to develop after the announcement, you can close out the whole play with only a minor loss in time value, because you only held the position for a week. The time decay will be minimal for the deferred option months in comparison with the front-month gamble for all-or-nothing winnings.
FedEx is scheduled to report earnings on Tuesday, Sept. 18, before the open. Options typically become more expensive as the earnings release approaches as buyers become more fearful of a surprise. To avoid a possible increase in volatility, and therefore in the price of the options, it is best to enter into a strangle at least a couple of days prior to an announcement. But because FDX has low volatility in relative terms, this is not as crucial a part of the trading plan.
FDX was trading at $88.70 a share at the time of this writing. We want to play both sides with just out-of-the-money options. The total cost of the strangle (call and put) should be less than 10% of the value of the stock. The more expensive the play in relative terms compared with the stock, the larger the move required to be profitable.
Recommended Trade Setup: Buy one FDX Oct 90 Call and one FDX Oct 87.50 Put for a combined total cost of $4 or less.
The breakeven is $94 on the upside ($90 strike plus $4 total option premium) and $83.50 on the downside ($87.50 strike minus $4 total option premium). Those points are only a modest 6% above and below the current share price.
If the company’s earnings announcement causes the stock to break to the upside or downside, exit the losing option and manage the trend with the winner. If a breakout does not occur, the maximum loss is limited to the $400 or less paid per strangle position.