Real Money, Real Trades Earnings Season Fails
Earnings season is just beginning and I have had two stocks so far that I really liked. Ones I thought had the potential to beat earnings and shoot higher.
Netflix (NFLX) was the first one and Newmont (NEM) was the second. I played them both the same way… I put on a pretty aggressive spread position that would target 200% to 300%.
Both of them reported fantastic earnings:
Netflix’s Second-quarter revenue beat Bloomberg consensus estimates to hit $9.56 billion, an increase of 16.8% compared to the same quarter last year! Netflix also added 8.05 million subscribers in the second quarter when analysts expected them to add only 5.1 million subscribers, that’s 3 million extra people that are being billed for Netflix subscriptions… A huge win for Netflix on what I consider their most important metric. Overall a fantastic report for the streaming giant…
Yet the stock plummeted. And I lost money.
We have a similar story with Newmont, we saw a second-quarter earnings surprise of a massive 35.85%.
Last quarter, it was expected that the gold and copper miner would post earnings of only $0.35 per share when it actually produced earnings of $0.55, delivering a surprise of 57.14%. Revenue came in at $4.4 billion, up 64% from last year’s second quarter which came in at $2.68 billion.
Wall Street analysts expected this quarter's revenue to come in at $3.48 billion, and remember, it came in at $4.4 billion…
So we have two quarters here of incredible outperformance. I am about to tell you that I hit it big, right?
Unfortunately, the stock has only gone down slightly since reporting these fantastic earnings.
Both sputtered out and did nothing and so I lost 100% on both of those options trades and the lesson here is, of course, earnings are risky and they don't always play out the way that they “should”.
I think most people know that lesson.
The second lesson here is that market sentiment weighs very heavily on earnings. When we see overall market optimism, we'll just naturally see more earnings plays be positive and vice versa.
So a lot of times people talk about earnings and just what the numbers are, or the prediction, or the talking points and whether it's optimistic or not. But we have two clear examples with Netflix and Newmont where none of that mattered.
In reality, there can be an overarching market sentiment that's hanging over even the best outcomes. And in this case, it was a relatively unhealthy market sentiment.
The Mood of the Market
There's also something I like to call the mood of the market.
For example, if you go back and look at Apple during the last earnings cycle, the mood was that Apple felt undervalued and it's one of those stocks that permanently has a great fan base.
The next iPhone was coming out, they released a ton of info about future AI projects, and a slew of updates… The mood was just very positive.
Apple then put up very mediocre earnings numbers and shot up big. And it’s a great example of how the mood and sentiment can be such a big part of earnings that you can't underplay.
I’m sharing this because I think these are things everyone should be aware of.
But the most important lesson is not about predicting earnings or even understanding the mood…
It’s that I always trade earnings with these very aggressive risk rewards.
And the way that I do that is mostly through debit spreads, (although I have a few other strategies that we'll get into eventually in this newsletter).
The reason that I typically use debit spreads is because I can set up 200, 300, or 400% targets in advance.
That's very important to me because on earnings, I expect my chances of winning to be 50/50 at best. And if I'm 50/50 at best, and I'm making only an 80% profit on my winners and losing 100% on the losers, then obviously I'm going to lose money.
But frankly, even 50/50 is tough to beat if you think about the three basic scenarios of earnings:
- Scenario 1: You're just plain wrong, it rips in the opposite direction.
- Scenario 2: The stock doesn't move at all and any kind of option is going to lose money and the underlying stock isn’t going to make you any money.
- Scenario 3: You were right, and you hit a big winner!
That essentially gives you a 33.3% accuracy just based on those three scenarios if you want to be very general about it.
And most people probably don't even win 33.3% of their options trades on earnings.
My target is a 40-50% win rate. I use lower risk (total amount traded), but I make sure I'm targeting 200, 300, or 400%.
So, over the course of 100 earnings trades, even if I am only at a 40% win rate, I will end up net positive because the winners are so big.
I think one of the big mistakes that people make is that they trade earnings with 50/50 odds and then they win 50% of the time and they actually end up losing money in the long run.
The Biggest Lesson
That, to me, is the biggest lesson. If you want to trade earnings, trade them as high risk, high reward, and make sure that the reward actually backs out over time into a positive position.
And for me, that's debit spreads and the way that we do that is we simply pick a spread where we can calculate our risk reward ahead of time.
For example, let’s say Netflix is trading at $550 and we are expecting an $80 move. So, we expect NFLX to rise to $620 per share.
But instead of buying a $620 option, I will choose a debit spread with strikes of $600 and $610.
In other words, I can target a lower move than expected and still generate around 200-300% return if Netflix jumps up over $610 –we have a binary trade for a winner or a loser, where our winner is significantly bigger.
So, if you win 40% to 50% of your trades over earnings season, you should come out way ahead.
Unfortunately, I've seen so many people, who should have come out ahead, but who didn’t set up their trades in a way that gave them enough reward for the level of risk.
In other words: If you’re going to trade high risk, make sure you get enough reward to pay it off!
- Nate Tucci
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