3 Rules for Trading on News Events

by John Jagerson and Wade Hansen | June 19, 2012 2:23 pm

Trading events and news is attractive because news is what can create a big move in a stock.

When something is announced in the news, be it earnings, new-product information or dividend releases, what’s happening is that information investors did not know previously is now known. So stock and option prices from the day before will now potentially be very different today based on the new information.

The trick with news investing is that we — and you — aren’t the only ones who know that stocks can move a lot on news — be it global, economic, stock splits, earning reports or merger-and-acquisition events. Other market participants know this, too.

That’s not to suggest that everyone knows the same thing or that they’ll react in the same way. It’s in these differences that opportunities lie.

Below are three rules to follow when trading the news:

Avoid Paying Too Much of a Premium

Do this by avoiding the crowds, trading peers and “selling the news” after the fact.

Knowing how to avoid paying too much is tricky. You have to understand how options are priced and under what conditions an options price may drop down long enough to grab a buying opportunity that isn’t too far away from the news event and that you can buy when premiums are low enough that the risk-to-reward profile is attractive.

Look for Stocks With Indirect Exposure to a News Event

This will help you avoid paying too much and to find more opportunities. For example, consider a stock that is very sensitive to its peers’ earnings reports. Then, rather than trading a stock that’s releasing its earning report, look at stocks in its peer group that may move with that stock.

Be Willing to Take Profits Before the News Report Even Appears

Sell “picks and shovels” to short-term gold miners. There are lots of times we may buy into a stock where we are way ahead of the news announcements, so premium inflation hasn’t started to take place yet. Then, as we approach the news event, that premium inflation starts to take place, and in some cases, it can be extreme.

So we’re able to buy in, ride the wave as the premium rises, then get out and not take the risk that the market will suddenly reverse following the big announcement.

Here’s a trade we’ve opened in our SlingShot Trader service[1]. Our traders got in at 2.67 on this, but it shouldn’t be too late for you to get in and enjoy some profits from this trade.

The market remains choppy following the Greek elections, but we’re not seeing the kind of chaos many analysts were fearing. While the rally may still be relatively fragile and traders are overly focused on Wednesday’s FOMC announcement, there are some interesting trades emerging.

“Buy to open” the RedHat (NYSE:RHT[2]) July 57.50 Calls. This position in RHT is designed to take advantage of very similar fundamentals and technicals that appeared the last time the company reported.

Earnings will be released the same day as the FOMC meeting, so it is possible that we may want to exit before the actual news, depending on overall momentum. If that were to happen, we would time our exit for the afternoon of June 20 rather than after the earnings announcement hits and trading resumes on the morning of June 21.

  1. SlingShot Trader service: http://slingshot-trader.investorplace.com/index.html
  2. RHT: http://studio-5.financialcontent.com/investplace/quote?Symbol=RHT

Source URL: https://investorplace.com/2012/06/3-rules-for-trading-on-news-events/
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