Second-quarter earnings season has arrived with several reports Friday from the financial sector. The coming week is also busy with names such as Netflix (NFLX), Bank of America (BAC), United Continental (UAL) and Visa (V) set to report.
Some could present compelling call-option trades.
An option strategy introduced by IBD helps minimize risk around earnings. Buy shares of a stock just before earnings, and you’re not protected if the stock gaps down in price. With options, the downside risk is limited by the amount paid for the contract.
A call option is bought with the expectation that a stock is heading higher in price. Put options are bearish bets on a stock. One call-option contract gives the holder the right, but not the obligation, to buy 100 shares of a stock at a specified price. One put-option contract gives the holder the right to sell 100 shares of a stock at a specified price.
Stocks typically trade weekly and/or monthly options, and every contract comes with an expiration date.
In the latest week, a few financial stocks with healthy charts presented low-risk call-option trades ahead of earnings.
JPMorgan (JPM) was holding near highs and in buy range from a 94.08 buy point ahead of its Friday earnings report.
When shares were trading around 92.75 Thursday, a slightly out-of-the-money weekly call option with a 93 strike price (July 21 expiration) came with a premium of around $1.08, presenting a trade with extremely low downside risk of 1.1% ($1.08/92.75). Downside risk was also quite low in contracts with July 28 and Aug. 4 expirations. Keep in mind, when premiums are priced this cheap, it’s a case of caveat emptor because with low risk often comes low reward. On Friday, shares were trading under 92, down nearly 1.5%.
One contract for the right to buy 100 shares of JPMorgan at 93 came at a cost of just $108, excluding commission. Always target trades with downside risk of 4% or less. Again, the maximum loss on this trade if JPMorgan had tanked was the amount paid for the contract ($108).
When shares were trading around 127.50, an out-of-the-money monthly call option with a 130 strike price (expiring July 21) came with an extremely cheap premium of 0.85, presenting a trade with downside risk of less than 1% (0.85/127.50). You could also look at an in-the-money strike price of 125. This contract offered a premium of $3.50, presenting a trade with downside risk of 2.7%. Early Friday, shares were trading around 126.62, down 0.6%.
Barracuda Networks (CUDA) was noted as a possible put-option trade ahead of its July 10 earnings report, when it was getting repeated resistance at the 200-day moving average. Price action like this is usually indicative of weak buying demand, but its technical health improved quite a bit when shares jumped 5.5% in heavy volume on July 7. The bullish gain disqualified it as a put-option play.
The coming week has some potential option trades to consider.
Netflix reports Monday after the close. It’s been working on a flat base with an entry at 166.97. In the latest week, when shares were trading around 157.75, a weekly call option with a 160 strike price came with a premium of $5.70, presenting a trade with 3.6%, near the high end of the threshold of 4% or less.
Bank of America, which reports Tuesday before the open, is working on a cup-with-handle base with a 25.21 buy point; United reports Tuesday after the close. It’s carving a flat base with an 83.14 buy point. Athenaheath is getting support at the 10-week moving average ahead of its earnings report Thursday after the close. Microsoft and Visa are near highs as they work on flat bases. Both report Thursday after the close.
For companies reporting after the close, scan option prices a couple of hours before the close. For companies that report before the open, scan prices late in the prior day’s session.
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