A Simple Option Strategy To Profit From Weak 3rd Quarter Earnings

| October 15, 2012 | 0 Comments

weak earningsThird quarter earnings season hits full stride this week.  Eighty-two of the S&P 500 companies and 12 of the 30 Dow Jones stocks report earnings in the next five days. 

Unfortunately, this is expected to be the worst quarter for earnings since 2009.

Analysts are forecasting S&P 500 earnings per share growth of -1.7% and revenue growth of -0.6%.  It’s the first time earnings growth has turned negative since the 3rd quarter of 2009.

Obviously, a slowdown in earnings growth is bad for stocks.

But here’s the thing…

Don’t forget, the third quarter was a time of great uncertainty in the global economy. 

At the time, the European debt crisis was reaching a boiling point.  And the European leaders seemed like they were helpless to prevent it from boiling over and derailing the entire global economy.

As a result, businesses were forced to take a wait and see approach.  They put plans on hold and were less aggressive with spending than they otherwise would have been without the crisis.

But as you know, the European Central Bank and other leaders were able to strike an agreement.  And it virtually assures us that interest rates on European sovereign debt will not be able to rise to a level that would trigger mass defaults.

Put simply, that’s great news for businesses everywhere.  With the uncertainty the crisis created behind them, companies are able to get back to doing business. 

But nevertheless, the damage was done. 

Right now we’re seeing the damage this period of uncertainty has done to corporate earnings and revenue growth.  And it’s not pretty…

The good news is negative earnings growth will likely be a one-time thing. 

Next quarter companies should get back to growing revenue and earnings like they were before the European crisis flared up.  So any selloff that results from a poor quarter should be a great buying opportunity.

And there’s no better way to buy stocks on a downturn than by selling puts.

Selling a put option obligates you to buy 100 shares of the stock you want to buy at the price you want to pay for it.  And you also collect an option premium that’s yours to keep no matter what happens.   

Take General Electric (GE) for example…

GE’s a rock solid company.  But the stock’s a little expensive after soaring 25% from around $18 to $22.67 in the last few months.

Let’s say you’re willing to buy 1,000 shares of GE if it falls back below $22 per share.

Selling the ten of the GE November 2012 $22 put options for $0.30 apiece is a great way to get into the stock if it falls below $22.

When you sell the options, you’ll immediately collect $300 (10 contracts times $30 per contract). 

If GE reports weaker than expected earnings on Friday, the stock could fall below the $22 strike price.  And you’ll likely be assigned 1,000 shares of GE at $22 apiece.  But since you collected the option premium, you’ll actually only pay $21.70 per share.

If GE doesn’t fall below the $22 strike price, then you’ll get to keep the $300 in option premium and you won’t be assigned any shares.

As you can see, selling put options is a great way to pick up shares of high quality stocks at the price you want to pay.  And you even get to make money if the stock doesn’t fall to the price you want to pay.  That’s win-win in my book.

Good Investing,

Corey Williams

Tags: , ,

Category: Options Trading Strategy

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.