The problem with buying a stock before its quarterly earnings announcement is that there could be a 10% move up or down once the earnings are announced.
If you correctly predict the stock’s direction, you could have a nice short-term gain on your hands. But guess wrong (or even guess right but have the company give weak guidance), and you could endure a loss that takes months to recover from.
What Is an Income-Oriented Investor to Do?
Short-term profits (measured in days or weeks) during earnings season are not impossible to achieve, especially if you’re using options to boost your gains. If your return goals are reasonable (say 2% per month), then using covered calls is a good choice … and probably a better choice than trying to make speculative bets on stocks you don’t know instead of getting situated in the ones you already own/want to own.
However, writing covered calls when there is an earnings announcement between your trade date and the option expiration date is not a recommended strategy. Yes, the premiums are juicy because of the pending earnings news. But if the company disappoints, then you could end up underwater quickly.
So, first thing to do is set your covered call screener so that it removes all covered calls that have an earnings announcement before option expiration. During earnings season, that will remove a lot of companies, but not all — especially if you are writing weekly options, which make it easier to avoid earnings risk because of their frequent expiration cycles.
The second thing you want to do is stick to larger companies, like the S&P 500. If you can find ones that have an ex-dividend date before expiration, then that’s great (but it’s not strictly required).
Let’s look at a few ideas for the upcoming January expiration (five days left) and February expiration (33 days left). We will set the screener to remove all stocks that have an earnings announcement before option expiration, and we will limit results to S&P 500 stocks only that have options that are at least 4% in-the-money.
Trade #1 — U.S. Steel January Covered Calls
U.S. Steel (NYSE:X) has been building a base above $25/share since November. If you’re not called then you own it at an adjusted basis of $25.79 and can write a Feb 26 strike. Standard & Poor’s gives it a four-star rating (out of five), and the analysts are slightly bullish (eight have “Buy” or “Strong Buy,” five have “Hold,” and two have “Underperform” or “Sell” recommendations).
The Trade: Buy at $27.47, then sell the X Jan 26 Call for $1.68. Net debit = $25.79. If called, you make 21 cents on $25.79, or 0.8% in 5 days, or 59% annualized.
Trade #2 — Salesforce.com January Covered Calls
Salesforce.com (NASDAQ:CRM) has fallen recently, and this bet is that it is unlikely to fall much further. The premiums are usually pretty good on CRM and, if you’re not called, then you should be able to write calls above your breakeven until called. Analysts like CRM right now: 10 have “Strong Buys,” 19 have “Buys,” seven have “Holds,” and three have “Sell” recommendations.
The Trade: Buy at $104.10, then sell the CRM Jan 100 Call for $4.90. Net debit = $99.20. If called, you make 80 cents on $99.20, or 0.8% in 5 days, or 59% annualized.
Trade #3 — Salesforce.com February Covered Calls
You can enter both the January trade and this February trade and collect both premiums, or choose to do one or the other. It’s up to you!
The Trade: Buy at $104.10, then sell the CRM Feb 100 Call for $8. Net debit = $96.10. If called, you make $3.90 on $96.10, or 4% in 33 days, or 45% annualized.
Trade #4 — JPMorgan Chase February Covered Calls
JPMorgan Chase (NYSE:JPM) appears to be on the mend, after a year of falling from $45-ish to $30-ish. If you sell the JPM Feb 34 Calls (detailed below) as a buy-write and they are not called, then you own JPM at an adjusted basis of $33.32. Not a horrible place to be.
You can probably write calls against it above your adjusted basis until it is called away. Plus it pays a 2.8% dividend. Analysts like JPM: 9 rate it “Strong Buy,” 16 rate it “Buy” and 3 rate it “Hold.”
The Trade: Buy at $35.93, sell the JPM Feb 34 Call for $2.70. Net debit = $33.32. If called, you make 68 cents on $33.32, or 2% in 33 days, or 23% annualized.
Position Size For Buy-Writes
One issue with short-term buy-writes is that, depending on which broker you trade with, transaction costs can dramatically affect returns.
When working with numbers like 68 cents per share profit, you really can’t be trading 100 shares at a time. That would only be a $68 profit per contract.
And from that, you have to remove your cost to buy the stock, cost to sell the option, and your cost to have it assigned.
If you trade at InteractiveBrokers or some other low-cost broker, then it might not be a big deal. But if you trade where it costs $10 or more per transaction, then you want to trade at least 500 shares (and sell 5 contracts) so that the commissions aren’t a huge percent of your gain.
