To The Moon

During an earnings season, if I expect the earnings of a stock to disappoint, a way to benefit from my expectation without actually forking out significant funds to acquire the stock may be to buy a put option with the stock as the underlying asset. I could then make a profit when the put option premium rises after the announcement of poor earnings or outlook. If however the earnings surprises on the upside, at most I would lose will be the option premium paid previously.

Alternatively, I could write a put option with a strike price that I would be willing to buy the stock when its price falls upon release of the earnings results, and earn the option fee upfront from selling the option that will help to subsidise my payment for the stock in due course when the option buyer exercises the put option, i.e. the right to sell the underlying stock to me at the pre-agreed strike price before expiry of the option.

If the earnings surprises on the upside instead, I will forgo the buying opportunity on the stock, but I would have profited from selling the put option earlier.

Conversely, if I were to predict overwhelming earnings results, I may acquire a call option with the underlying stock at its prevailing price to take advantage of the rising share price after the earnings results has been posted. At most I would lose the option fee paid upfront in case the stock price unexpectedly sinks on underwhelming results or disappointing business outlook, it is a comparatively small price to pay rather than buying the stock directly only to see its share price sinks.

An alternative to benefit from

optimistic view that one may have on the earnings would be buy the stock before its earnings results and simultaneously write a call option with a strike price that he would like to sell the underlying stock if the expected share increase materialises on good earnings results.

The option fee earned should be commensurate with the risk that one has to undertake in case the stock price unexpectedly sinks on underwhelming results or disappointing business outlook. The option premium would help to offset partially the loss he would suffer in unfortunately having bought the stock with falling share price.

Yet another alternative may be to buy the stock on expectation of rising share price when the earnings results is released, but hedge against unexpected loss due to falling share price when the earnings turn out to be worse than expectations by at the same buying a put option with the underlying stock. The option fee can be regarded as an insurance premium paid for insuring against the risk of dropping share price unexpectedly.

In summary, options trading can help us to profit from our earnings expectations for the underlying stock, and hedge against or mitigate the risks of wrong predictions.

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