When it comes to using puts and calls in earnings season, there are two schools of thought. The more conservative approach is to avoid using them altogether. Earnings reports can create havoc with stock prices, and opening positions in puts and calls could backfire and cheat you out of larger gains.
Puts and calls can certainly be used as hedges, but as I will discuss in my forthcoming stock advisory newsletter, The Liberty Portfolio, I’m not a fan of using them as hedges except in extraordinary circumstances.
The more aggressive approach, and I will sometimes engage in this strategy in very specific circumstances, is to go right ahead and use puts and calls to generate income..
Earnings season brings higher volatility, which in turn brings the opportunity to earn higher premiums on puts and calls. Remember, right before and right after a company reports (mostly after), you can see stocks move a lot in either direction.
Earnings Puts and Calls: Priceline (PCLN)
Priceline Group Inc (NASDAQ:PCLN) is probably one of my favorite plays with puts and calls.
PCLN stock sells at a net cash-adjusted price of $1,370, or roughly 20 times FY16 earnings. It is growing its EPS at a 17% annualized rate, and I consider it pretty close to a “growth at a reasonable price” stock.
You might want to consider selling the Dec. 16 $1,300 naked puts for $20, and collect a whopping $2,000 in premiums. The later expiration date gives you time for buyers to return to PCLN if they bail after its early November earnings report.
Alternatively, if you own PCLN stock, you could sell the Dec. 16 $1,500 covered calls for $50. If PCLN has a great quarter, the chances are that it’ll be called away, but you can always buy back in. If the third-quarter earnings disappoint, you’ll have just pocketed five grand and hedged your downside.
Earnings Puts and Calls: Starbucks (SBUX)
Starbucks Corporation (NASDAQ:SBUX) has been hovering at the lower end of its year-long trading range, at around $53. With a 19% annualized growth rate going forward, and trading at about 27 times estimates, SBUX is not unreasonably priced. I’d like it more if it were a bit cheaper, but getting a true growth stock and great brand name like SBUX at even this price is totally rational.
Thus, this trade depends on which direction you think SBUX stock goes after earnings.
If you think it will go up, then consider selling the Nov. 25 $53 naked puts for $1.42, which is a nice and generous 2.7% return for a 36-day holding period. That comes out to 27% annualized.
If you think SBUX stock will go down, and you own it, then sell the Nov. 25 $53 covered calls for $1.45. You get the same return here, and you’ve cushioned your downside by that amount.
Earnings Puts and Calls: Wynn Resorts (WYNN)
Wynn Resorts, Limited (NASDAQ:WYNN) has provided great opportunities for those using puts and calls. WYNN stock roared back from the $60 range to just over $100 as the Macau business stopped its insane skid. It’s still not the best place to be as far as casinos go, but this situation will pass, and I think WYNN stock at $95.50 is a compelling trade with long-term upside.
WYNN could whipsaw wildly, but I think there is greater risk to the downside than it has to go up. If you are using puts and calls for income, what’s the best play? I think that if you are in this for the long-term, then selling the Jan $90 naked puts for $5.
If WYNN shares get put to you, you get them at an equivalent price of $85, which is not bad at all. If they don’t, you make $500. There’s no reason to go long the stock and take the risk of Macau falling apart again if you can grab $500 of upside.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
