CVB Financial Corporation (NASDAQ:CVBF) : Side-Stepping Stock Direction Risk in Option Trading Before EarningsDate Published: 2017-10-12
For the investor that feel as though the market's direction is becoming tenuous, we can explore an option trading opportunity in CVB Financial Corporation (NASDAQ:CVBF) that does not rely on stock direction at all. It turns out, over the long-run, for stocks with certain tendencies like CVB Financial Corporation, there is a clever way to trade market anxiety or market optimism before earnings announcements with options.
The Trade Before Earnings: When it Works
What a trader wants to do is to see the results of buying an at the money straddle two-weeks before earnings, and then sell that straddle just before earnings.
The goal of this type of trade is to benefit from a unique and short time frame when the stock might move 'a lot', either due to earnings anxiety (stock drops before earnings) or earnings optimism (stock rises before earnings), but taking no actual earnings risk.
If the stock is volatile during this period, this generally is a winning strategy, if it does not move, this strategy will likely not be profitable and the complete back-test below discusses that possibility.
Here is the setup:
We are testing opening the position 14 calendar days before earnings and then closing the position 1 day before earnings. This is not making any earnings bet. This is not making any stock direction bet.
Once we apply that simple rule to our back-test, we run it on an at-the-money straddle:
We can add another layer of risk management to the back-test by instituting and 40% stop loss and a 40% limit gain. If the stock doesn't move a lot during this period and the options begin to decay in value, a stop loss can prevent a total loss.
On the flip side, if the stock does move in one direction or another enough, the trade can be closed early for a profit. Here are those settings:
In English, at the close of each trading day we check to see if the total position is either up or down 40% relative to the open price. If it was, the trade was closed.
If we did this long at-the-money straddle in CVB Financial Corporation (NASDAQ:CVBF) over the last three-years but only held it before earnings we get these results:
The mechanics of the TradeMachine™ are that it uses end of day prices for every back-test entry and exit (every trigger).
We see a 49.2% return, testing this over the last 12 earnings dates in CVB Financial Corporation. That's a total of just 156 days (13 days for each earnings date, over 12 earnings dates).
We can also see that this strategy hasn't been a winner all the time, rather it has won 6 times and lost 6 times, for a 50% win-rate.
While this strategy has an overall return of 49.2%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 35.7% over 13-days.
This is it -- this is how people profit from the option market -- finding trading opportunities that avoid earnings risk and work equally well during a bull or bear market.
Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.