Earnings season brings both excitement and trepidation to investors. There is nothing more exciting than waiting for a company you own to report, expecting good results, and getting a report that blows away estimates and sends your stock soaring.
Conversely, there’s nothing worse than expected a beat and having your stock miss by a mile, sending both you and your stock into the depths of despair.
Options can be an effective tool to load up on a long position, if you expect earnings to boost your stock. However, it is the use of puts to hedge a position that may come in handy during earnings season. That is particularly true of blue chips.
Blue chips have the advantage of not being terribly volatile. Consequently, purchasing puts (in which you profit if the stock goes down) is a way to hedge against a bad earnings season report at a relatively inexpensive price. Blue chips can be hammered on a bad report, because then a stock perceived as safe may suddenly not be perceived that way.
Here are three option plays for blue chip stocks to hedge your positions as we head into earnings season:
Blue-Chip Stocks for Earnings Season: Halliburton Company (HAL)
One of the big energy blue chips that may very well deliver bad results is Halliburton Company (HAL). I think most people expect HAL stock earnings to be bad, but it’s possible that they may be awful.
Fortunately, the options market has kindly offered a Jan. 23 expiration date so that options will not have a lot of time premium baked in to push up the cost of the puts.
I like to try and protect against total disaster. A drop of a buck or two in HAL stock isn’t what concerns me. Stocks are going to move 5% or so on earnings, and that’s to be expected. But given the devastation in the energy sector, this is a prime candidate to fall even more.
As I write, the company trades at $38.29, so I would consider buying the Jan 23 $36 puts for 35 cents. That’s less than 1% of the cost of the stock to insure the stock against a huge drop.
Blue-Chip Stocks for Earnings Season: International Business Machines Corp. (IBM)
The situation with International Business Machines Corp. (IBM) isn’t much better this earnings season. As I wrote last week, I expect IBM to be the worst-performing blue chip stock in the Dow in 2015.
The company is like a fossil that people think is cool, and so they hold onto it for no good reason.
That’s why I expect earnings for IBM stock — core earnings after you back out the stock buybacks — to be miserable. The market may not realize this at first, but it will. At some point, I believe there will be a mass exodus from IBM stock. I just don’t know when.
So, with IBM stock trading at $156.81, I would consider the Jan 23 $155 put for $2.82. It’s a bit more expensive than I’d like, at 1.8%, but I think it’s a decent price to pay. I wish there were other strike prices before $152.50, though.
Blue-Chip Stocks for Earnings Season: Johnson & Johnson (JNJ)
I’m also bearish on Johnson & Johnson (JNJ), which I regard as another company in decline that investors will sooner or later wise up to. Again, look for financial engineering in the earnings season report. I think JNJ stock, in particular, is susceptible to a big breakdown because it is so identified in the minds of conservative investors as a “safe” blue chip.
All it takes is one bad report, and JNJ stock will be pummeled as people rotate into some other healthcare company.
Right now, JNJ stock trades at $104.76. Fortunately, we have a bunch of strike prices to choose from in this options batch. Again, I want to protect against disaster, so overpaying for a strike close to the current trade isn’t on my agenda. I would consider buying the Jan 23 $102 put for a mere 40 cents. That less than 0.4% for insurance, and I think it’s well worth the price.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He is the Manager of the forthcoming Liberty Portfolio. He can be reached at TheLibertyPortfolio@gmail.com.
