A few weeks ago, Goldman Sachs' options research team looked at the historical returns that would have been yielded by a strategy of buying at-the-money call options on stocks five days before their earnings, and selling them the day after.
Since a call represents the right to buy a stock for a certain price within a given time, this is a bullish strategy that would tend to profit as a stock rises. And since the average stock rises on earnings, those call options tend to pay off, Goldman found.
Generally, the strategy has yielded a profit of 14 percent, and 16 percent when it comes to stocks with liquid options. But as it happens, the first 38 companies with liquid options that have reported earnings have shown call buyers a return of 48 percent, tracking for one of the best years in Goldman's study going back to Contributing to the bonanza for options traders have been names like Phillip Morris and Netflix , which would have shown call buyers profits of percent and percent, respectively.
That's a percent profit in a week. Of course, not every name soars on earnings. But Goldman's point is that because investors tend to be skittish and expectations tend to be overly bearish, stocks rise off of earnings more often than they fall, and the values of call options rise along with them. However, buying calls outright ahead of earnings may not be the best strategy, some traders warn. Once the earnings come out, volatility drops, and this can hurt long options positions. To reduce the effect of falling options prices on his positions' values, Keene chooses to use "spread" trades, whereby he sells options at the same time he buys them.
That reduces his exposure to the overall prices of options ahead of a highly anticipated event. However, the downside of doing a spread is that one often only captures part of a massive move, rather than getting the unlimited upside. This version corrected the percentage of profit in the Amazon options trade to percent. Want to be part of the Trading Nation? If you'd like to call into our live Monday show, email your name, number, and question to TradingNation cnbc.
Simple strategy reaps massive profits on earnings Alex Rosenberg AcesRose. It's been a great earnings season for options traders. Download the latest Flash player and try again.More...