Holding Over Earnings: My Opinion

Ok, so as long as I have traded and watched investment shows and been part of trading communities this question always comes up. "do I hold over earnings?" That depends. In my opinion, earnings speculation can be fairly profitable, it can also lose you money. First lets remember the lesson I learned the hard way.

If you are holding OTM options going into earnings and plan to hold, at least switch to ATM or ITM options.

Even holding over earnings you are going to want to estimate your risk and keep it at 2%.

Here is what I do to decide if I will hold, depending on which way I think the stock will go, I will see what has it historically done? Does it run up into earnings and then sell off on good reports, does it stay fairly flat then gap up?

Obviously, in any case you want to increase your probability by looking at those things. See how many times has the stock beaten lately if you are bullish, does it usually beat in the quarter they are about to report? Is it logical that the stock should do well, has it been talked about lately on how well its doing(or how badly if you are bearish).

What is even better is if you can quantify yourself. Like I did with AAPL, however that may not always be doable. Here is what I did, this was all from either internet statistics and logical guessing based on past performance. You can see I was slightly off, but much closer than the analyst estimates.

Apple Q3 earnings estimate

Previous 2006 Q3 notebook sales 798,000

Reported notebook growth compared to year ago, 65%

798,000 x 1.65=1,316,700

Average notebook cost 1,400

1843380000 x .3=553014000

Assuming 30% margin(previous margins)

Desktop sales

Previous 2006 Q3= 529,000

Assuming slight drop in desktop sales 500,000

Average cost 1,300

650,000,000 x 30% = 195,000,000 .

Iphone Q3 sales 500,000

Average price 580

Ipod Q3

Previous 2006 Q3 sales 8,111,000 which was 32% over 2005

Assuming a drop in growth year over year due to iphone lets say 25% growth

8,111,000 x 1.25 = 10,139,000

Average cost assumption 200 dollars

Supposed comments that margins on ipods are “above 20%”

Let’s assume only 20% margins

10,139,000x200= 2,027,800,000

Other music related revenue assumptions

Previous year Q3 457,000,000

Q3 2007 500,000,000

Peripherals

236,000,000

Software, service and other sales

350,000,000

Margins unknown

Total Revenue Estimate

$5,897,180,000

Prediction is for 14.6% profit(equal to previous quarter profit level)

Using that prediction

Profit= 860,988,280

Total EPS= .995 for 864, 950,000 outstanding shares

So, getting all of this is fine what will the stock reaction be? You honestly don't know but using the above things to your advantage can give you an idea, I also compare to what is currently happening. On good earnings and guidance stocks were gapping up approx 10% from similar companies, so I figured 7%-10% move was possible. I was right, but like I said hadn't learned about IV decay after earnings, so I screwed myself.

For GOOG, I figured we would get a run up to 640, I had bought the 640's hoping it would end up in the money before, but it was ATM, I assumed we would get a move to 650 on good earnings at least, being a round psychological number and validating current PE. This move would be hopefully good enough to offset IV decay and then some, it may not have worked out how I planned but I may be able to break even or take a slight loss which is ok because the money making potential was decent and if you can take a few small losses or break evens and get a good gap up(like on ISRG) you'll do fine.

So, if everything checks out I'll hold, a small position now over earnings, if I am unsure I won't hold.

GOOG earnings

Well, GOOG reported earnings after the close today, the stock closed right at the money for my option and I was up slightly on it so I figured I would hold expecting good results. Good results came, stock initially moved down, then up to 650, then fell back down to 643.5. I was hoping for more.... At this point I am hoping to get out of it even, even though I think it is going higher in the long run, Oil hit $90/barrel afterhours which I think will weigh on the market a lot tomorrow. I will watch it tomorrow and if it is looking like it won't rally any during the day I will likely exit.

Now on to the previous dilemma. FCX, I sold out of this for an 800 loss, which is right at my 2% level. Of course then on the marketcast tonight Jeff says FCX is a great play to be in, oh well. I made a decision and I will see what happens, had I held till close I could have gained another 150 back, but I again had to leave before the close.

ACH, which had inexplicably ran up 10 dollars yesterday(well I think the explanation had to do with China and hong kong exchanging shares) pulled all the way back to 80 dollars, which is where it was having trouble breaking before. I took down 5 contracts a little under 81, with a target of back to its high, possibly take it to the century mark. if it breaks that 80 mark, it doesn't have much support until 70 so I will exit if 80 is broken. a 1:9 risk/reward, which I would always take.

I still want to get some put plays going, maybe on the XHB or some banks, most are already low priced though, JCG could be good but its not very liquid.

Here is how the account stands at the close with my options:
FCX(closed) -800

ACH +250
AAPL +1,375
GOOG +60

A Dilemma...

Well, a little update on the positions.

AAPL Nov 170 calls +1,375 (good)
GOOG Nov 640 calls -90 (eh, took a 6 dollar move over where i bought at to get back to about even)
FCX Nov 120 calls -1,100 (Terrible)

Ok, so as we can see, 2/3 somewhat working out, however FCX is down 1,100, which is over my 2% risk I want to limit losses to.

As we went into the close there was a rally, which was good, I spent the last hour before close in the car though, at the the time I was down about 850 on the call, just over my limit but it still wasn't the end of the day.

So here comes the dilemma, I got into FCX at 115, wanting to play the momentum going into earnings I was giving it a 2% loss forgiveness. So now, I am sitting at almost a 3% loss, however, FCX has not broken recent support at 110, in the meantime my call loses time value and volatility. So what do I do? Hold until it breaks 110 and possibly lose more than even the 3% I have already lost? Or sell out now and assume it continues down but limit my loss to only 3%.

I have yet to decide, what I should have done in retro spect is wait for a pull back to this support level and then get in, so there is a learning experience. I am less inclined to sell because the actual trend hasn't technically broken combined with stocks normally going up before earnings, but I am losing more than my wanted 2%.

The good news is I am up 150 over when I started the positions, however I would be 300 richer had I cut the loss exactly at 2%.

I'll see how the day shapes up tomorrow. If anyone has input on suggestions that has more experience let me know.

Trading Rules

Here are my rules I have come up with so far. Most of these concepts are adapted from Jeff Kohler's blog and tailored to fit my trading style. I will discuss the rules under the list.

1. Plan the trade, trade the plan. Determine entry point, exit point, price target and time needed before entering the trade.

2. Be patient, wait for low risk entry points, these higher probability trades will be worth waiting for.

3. Only risk 1-2% capital per trade(as account grows position size will naturally grow as well).

4. There will always be more opportunities, if a trade is missed wait for another entry point or better trade altogether.

5. Take trades that are the logical easy money, that you have conviction about.

6. Do NOT trade in the first hour unless absolutely necessary.

7. Do not put on a full position unless it is a very low risk entry point and risk is clearly defined.

8. The trend is your friend, do not go against it unless a pattern confirms reversal.

9. Cut losses short when confirming break of support, let winners run unless chart or news of company says otherwise.

10. Trade(in general unless situation determines otherwise) one strike out of the money options with appropriate time for target.

As a trader all we should really be concerned about is probability. How can we gain an edge over the market in the long term? We do this by only getting into high probabilty situations with defined risk. If we create a plan before we enter a trade, emotion should be essentially eliminated. This is because we already know how much we may lose and it is within our risk tolerance. If we know we are only risking 2% of our capital and we can rest easy knowing that is likely all we will lose.

How can we increase our probability of success?

We cut our losses at 2% always and let our winning trades go until they reach our targets, unless they signal an early exit or break of trend.

We only choose trades with higher probability, trade with the trend, wait for confirmation before taking trades, and trade relative strength or weakness stocks.

We diversify our portfolio with multiple higher probability low risk trades, with both put and calls plays and hedges. For example if we have 10 positions on at once that gives us a better chance of being right at any given time.

ALWAYS follow your rules! The purpose of these rules is to be able to trade almost mechanically without emotion. Most people fail because they hope when they should fear and vice versa, since we already have a plan and rules we don't need hope or fear, we simply follow our rules knowing probability is in our favor in the long run.

These are my rules, feel free to use them or change them to make them your own, but make sure you take responsibility for your own trades.

As I learn and adapt these rules will be updated as I feel appropriate.

Back in the Game

So after selling out Friday somewhat prematurely, I was lucky enough to get pull backs today in many of the current stocks of interest which ended up working in my favor this time, mostly AAPL, GOOG, POT, DRYS, ISRG, FCX, BIDU, FSLR. These are stocks that have been discussed over on Option Addicts. Those are all currently bullish plays and patterns and I need to put on some bearish plays, I think possibly now more than ever.

After today I am slightly concerned, although looking at a 3 month chart the S&P and Nasdaq are sitting at what appears to be diagonal support, so I'll have to watch that closely, I may buy a few puts on the S&P as insurance. Jeff discussed hedging with gold and oil which I am looking into as well.


I took long calls in AAPL, GOOG, and FCX

If I get a close significantly below 165 on AAPL I will exit, I got in with the stock at 165.8, looking for it to get back up to 170, if it doesn't break 170 and close above the next time it gets to it I will likely exit since it hasn't been able to a couple times now however if it does I will stay in till 175. So my risk/reward ratio is approximately 1:5 at worst, very good. In general I will try and stay above a 1:4 ratio, lowest is 1:3. 165 in apple has been recent short term support, I think more significant support would be found at 150. In this case I am partially playing the run up into earnings which happens on Oct 22nd. If my options get into the money(Nov 170's) then I will sell part of the position and hold part over earnings. I am currently up slightly on these calls(+275) on 5 contracts. The stock was bought fairly heavily going into close, which is encouraging, I am hoping it was institutional buying and not short covering.

GOOG, I bought 1 contract of 640 november call, again a play on likely run up into earnings and increased Implied Volatility(IV). I like the pull back today because it gives head room for a run back to new highs before the report. My line is 620, I got in at 626, with a projection of 650. I took it at 626, because during the day it was holding there but fell some, 620 is my line, if it closes below I will exit. It did fall below during the day but going into close rallied back above, it wasn't as strong as I'd like closing basically right at my line but it did rally, and I feel like it shouldn't have too much downside before earnings. Currently, I am down slightly(-220). Again if I am significantly in the money going into earnings I will hold. I feel if they have a good report with good guidance we see a gap up, since last report people sold so heavily, however it has ran up almost 100 points in a short time so we could see selling on the release. GOOG reports on thursday the 18th. risk reward is about 6:24, or 1:4, fits my criteria.

I bought 5 calls on FCX around 115.10, target of 120, earnings report on the 22nd as well. 110 is more significant support, 115 has been recent. I bought these in the middle of the day, I likely should have waited on all of these to the end of the day, however they were close to my entry points so it shouldn't matter. FCX was rallying into the close with the others so I stopped paying attention, but somewhat stalled and fell back below 114 so I am somewhat concerned. I should haved paid closer attention, so now I will have to watch it tomorrow, I am only down .75%(-275), so it is within my risk tolerance of 2%, normally I would want to only have to lose that much to determine an exit, in this case I am somewhat playing momentum and slightly looser. However, if I get down my 2% I will exit.

So overall on the day, I am down less than 1% in my portfolio overall, which I like on a day where the nasdaq was down 1%.

I can use that to illustrate the importance of position sizing, and minimizing risk. I waited and took positions at points close to where I would need to exit. Positions are small since that is needed to keep risk in check. I would like to be more diversified with some put plays, if earnings aren't as strong as people think the market may turn over again, it will likley be volatile for now.

I'll try and find some bearish plays tomorrow, Jeff Kohler releases his weekly watchlists on Tuesdays which are extremely helpful, if I see some bearish setups I like I will likely take some.

I'll post on my rules so they are more clear, a little later but wanted to get those out there with some thoughts on what I did and why I did it.

"By the Grace of Kohler"

In June of 2007, after I had been trading options about a month I came across another blog after I was looking for technical analysis videos on YouTube. After watching a video he gave the address for his blog www.optionaddict.blogspot.com and the rest is history. :-)

I am always the first to give credit where it is due and I have to give almost all credit for my quick progression to Jeff Kohler. Jeff is an instructor at Investools and a professional trader. He also manages to run his amazing Option Addict blog. Everything up until I started reading Jeff's blog was simply information and ideas on how to succeed. Jeff was the example of success I needed with finite examples of trading that really hammered home concepts and made me change my old ways. I have to also give credit to the incredibley helpful community as well.

Through Jeff's blog I quickly saw the error of my ways and how I could improve my trading. I honestly believe that is the single resource anyone needs to learn to be a successful options trader as long as you can follow the rules you end up developing.

After learning technical analysis and reading Jeff's blog and exchanging a few emails I have since realized a few things are dumb to do if you are a trader.

Averaging down, if you chose a low risk entry point, you will never need to "average down" such as outlined in Cramer's books because if the stock drops you know to exit the trade.

Jeff's rules stress low risk, small position sizing, which is crucial to success. Before I would put on a huge position, thinking this was the way to make money. Having seen my new method work with way less risk, there is simply no reason to risk a high amount.

I have come up with my own trading rules after having learned from Jeff. These are basically Jeff's own rules but worded to my liking, I keep a copy of these on the wall next to my screens so I always have a reminder to not do something stupid and risk too much capital.



I cannot thank Jeff enough for the help and guidance he and the blog have taught me, hopefully I can help others through this blog and they can see value in my methods. Jeff is definitely someone I would like to meet someday and hopefully I will. By following my rules I learned I have been to get back to only 21% down from 50% down in the 3 weeks I have been back trading. Later I will describe how I now look and analyze all trades and why I think that way, which should help as I journal.

A little note about the title and picture. On Jeff's blog there was a down day in the market on thursday October 11th. Most people were upset and lost quite a bit of unrealized gains due to the unusual swing in the nasdaq. One blogger wrote "by the grace of God I had sold most of my positions earlier in the day". I posed to them that if it had been the "grace of God" then he must really love them and hate all the other Option Addicts to let them lose money. He then replied and said no it was actually due to his positions hitting their targets and being properly positioned and diversified that he was fine which was thanks to Jeff Kohler. I then decided he was actually saved "by the grace of Kohler". I liked that line and found it appropriate and humorous, hence its use here for my own situation. I have seen the light of Kohler, and it is good, lol.

Ben's Book Review

Before I even started trading I read a few books to get started and continue to read others to try and learn even more. I will basically summarize a book, give my opinion on if it is worth reading or not.

The Little Book That Beats the Market.
By Joel Greenblatt

This was the very first book I read on investing and stock picking. This is a great book for those just starting out and learning how to value stocks. It describes the concepts of valuation in very easy terms since he wrote the book to be readable by younger kids as well. Up to that point I had ideas on valuation, but this book gave good easy examples on picking stocks that were undervalued. The book basically referenced a "magic formula" which is basically high return on equity, high earnings yield and getting companies with little to no debt. His even setup a website www.magicformulainvesting.com for free and a few stocks I picked from there that I still watch would have yielded great gains(50%+). It is supposedly backtested to have returned 29% annually over 30 years.

I recommend this book for beginners just learning about stocks and valuation, very worth it.

Real Money: Sane Investing in an Insane world.
By James J. Cramer

Jim Cramer of Mad Money fame wrote this first book on investing. This book covers some good disciplines and has some good advice on how to pick stocks given the time in the economic cycle. Gives pretty solid advice on diversification and when to take risk. Gives good examples and also teaches about how to value stocks. It is easy to read and written in a fun kind of tone, if you have watched Mad Money you can see the personality come through in the writing.

I recommend this book for beginners learning about diversification, risk tolerance and economic cycles.

Mad Money: Watch Tv, Get Rich
By James J. Cramer

The second in his series of investing books, basically builds on Real Money with some good additions and newly found insights. Also talks about his show a little as well. One nice thing is it gives you a template on how to do homework on the stocks you are looking at to see if they are good candidates.

I would recommend this book if you have already read Real Money.

Confession of a Street Addict

By James J. Cramer

This is basically the history and background on Jim Cramer and how he got to where he is today and some of the interesting things that happened to him. I actually enjoy books like this because I like to see the history of those that became successful and how. Cramer is a talented writer, since he originally was a journalist, and the book is very entertaining.

I recommend this book if you are a fan of Cramer, it is well written and gives a great account of his journey to wall street and making money.

Seven Years to Seven Figures
By Michael Masterson

The only good information I got from this book was that if you want to make money and become a millionaire it must become your primary goal. I took this advice and hence started educating myself on the market and options. The rest of the book is worthless, you just get these stories from people that "did it" even though you have no idea how much they even started with. Page 40 basically tells you "it takes money to make money".

Do not waste your money on this book, I have given you the only valuable piece of information from it.

All About Option

By Thomas McCafferty

This is a good book for those looking to get information on options and different basic strategies to use. This will give you a good definition of options and will explain how they can be used more in depth. However this information is pretty much available online all for free.

Good for an intro to options but all the information can be found online from places like investopedia for free.

The Way of the Turtle

By Curtis Faith

Curtis Faith was supposedly the most successful of the "Turtles" a sort of experiment taking people with certain characteristics and seeing if they could be turned into good traders. This is a somewhat entertaining book, the story gives some good examples of why he succeeded and others failed, similar to the real world where 9/10 people fail to trade successfully. Basically the "secrets" of the turtles, are the usual let your winners run, cut your losses short. Add to positions if your position is being successful, only risk a finite amount and don't trade on emotion. Also, highlights the helpfulness of Technical Analysis.

Again another book to see how one person became a successful trader which I find interesting. I basically gave you the secrets and general themes, which should not be taken lightly because they are correct and should be followed if you wish to be successful.