Strategies to manage stocks around earnings season

Investors may find that some stock positions need more attention than others, especially around earnings releases, when stock prices typically become more volatile. In this article, we cover a number of strategies to manage the risks and opportunities of stocks around earnings season, whether you have a bullish, bearish or neutral outlook on a stock.

This article covers strategies that use options. Compared to investing in stocks, investing in options involves higher risks and requires a more advanced knowledge of investing. In the options examples given in this article, calculations of profit and loss do not include trading commissions, for the sake of simplicity. We present a limited number of options strategies from the perspective of managing the risks and opportunities of stocks around earnings season. However, this is not a complete review of the many options strategies available to investors.

We start with bullish earnings strategies, where an investor expects a stock price to increase around an earnings release.

Investors can buy stock when they expect the share price to increase around an earnings release. This is the simplest way to increase exposure to a company that you’re bullish on.

Investors can also use a long call option in this scenario. Suppose an investor owns ABC stock trading at $100 and buys a call option for $2 at a strike price of $110 and with an expiration date after the earnings release. The call option will be profitable at any price above $112 — the strike price of $110 plus the $2 cost or premium. Although a long call option can be held without owning the stock, investors can also use it to increase their exposure to an existing position.

The downside of the call option is that if the stock price does not reach the call strike price by the expiration date, then the call option will expire worthless. This differs from holding common stock, which is typically issued without any expiration date.

Why use a long call option rather than a stock purchase? A call option enables an investor to gain leveraged exposure to a stock, where one dollar of capital provides more than one dollar of exposure. This can be useful when investors have a limited amount of cash on hand or do not wish to sell other stocks to free up extra cash.

Investors can use a covered call when they expect the stock price to increase only moderately around an earnings release. For example, an investor owns ABC stock trading at $100 and sells a call option for $1 at a strike price of $105 and with an expiration date after the earnings release. The investor has sold off any upside above the call strike price, so the maximum profit is $6 — the call strike price of $105 less the initial stock price of $100, plus the premium of $1. In this example, the premium is a positive amount for the investor, since they receive the premium from selling the option.

The downside of the covered call includes that it provides limited protection against a decline in the stock price — the protection is limited to the amount of the premium — and that the investor has sold off any upside above the call strike price. This is why investors typically use the covered call when they expect only a moderate increase in price, and not when they expect a large loss or a large gain.

Next up, we discuss bearish earnings strategies, when an investor expects the stock price to decrease around an earnings release.

Investors can sell stock when they expect the stock price to decrease around an earnings release. This is the simplest way to decrease exposure to a stock.

Investors can also use a protective put in this scenario. For example, an investor owns ABC stock trading at $100 and buys a put option for $5 at a strike price of $100 and with an expiration date after the earnings release. This means that the investor has locked in a price of $100 until expiration or until the option is exercised, even if the stock falls below this level. The investor’s loss is limited to the $5 premium paid for the option.

The downside of the protective put is that if the stock price remains above the put strike price, then the option will expire worthless. The protection provided by a put option is not free; investors have to decide whether it’s worth paying for the protection.

Why use a protective put rather than a stock sale? One reason is that the investor might be bearish over the short time but bullish over the long term. The put option enables the investor to keep their current portfolio in place, while adding a level of protection. Another reason is that selling the stock may result in a taxable capital gain. The put option enables the investor to reduce their exposure to a stock, without triggering a capital gain on the stock position.

Finally, we discuss neutral earnings strategies, where an investor is not sure whether the stock price will move up or down around an earnings release.

Investors can use a long straddle when they expect a significant move in the stock price around an earnings release but are not sure whether the move will be up or down. For example, ABC stock is trading at $100. An investor buys a long put option for $4 and buys a long call option for $3, both at a strike price of $100 and with the same expiration date that is after the earnings release. The investor’s cost is the sum of the two premiums — in this case, $7. The investor needs to cover this cost to realize a profit. If the stock price moves by more than $7 up or down from the strike price of $100, then the investor will realize a profit, as long as they sell the option pair for a combined price of $7 or more.

The downside of the long straddle is that if the stock price remains at the strike price of $100, then the investor will lose both premiums. This assumes they haven’t sold either option prior to expiration.

A long strangle is similar to a long straddle but instead the investor uses strike prices that are out of the money. For example, ABC stock is trading at $100. An investor buys a long put option for $3 at a strike price of $95 and buys a long call option for $2 at a strike price of $105, both with the same expiration date that is after the earnings release. The investor’s cost is the sum of the two premiums — in this case, $5. The investor needs to cover this cost to realize a profit. The investor can profit in two ways:

1. If the stock price moves below the put strike price by more than $5 and the put option is sold for more than $5.
2. If the stock price moves above the call strike price by more than $5 and the call option is sold for more than $5.

The downside of the long strangle is that if the stock price remains within the two strike prices, then the investor will lose both premiums. This assumes they haven’t sold either or both options prior to expiration.

How does a long strangle compare to a long straddle? The long strangle requires a bigger move in the price of the stock for the investor to realize a profit. At the same time, the long strangle has a smaller cost or premium, since the strike prices are out of the money.

Both long straddles and long strangles can be achieved by holding options only, without holding the stock. However, investors can use these strategies to add exposure to an existing stock position, when they expect a large move up or down in the stock price.

For further details on options strategies, refer to our options trading course. The options trading course provides more nuance on options trading, including how the price of options rises in response to actual or expected increases in volatility. This can reduce the value of the protective and speculative strategies mentioned in this article. Consult the options trading course for a deeper dive on how to trade these and other strategies.

Stock price volatility tends to increase around earnings releases. Investors who want to manage the risks and opportunities arising from this volatility can choose from a range of strategies, depending on how they expect the stock price to move.

• Bullish strategies include a stock purchase, long call option and covered call.
• Bearish strategies include a stock sale and protective put.
• Neutral strategies include a long straddle and long strangle.