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My Go-To Setup…

Hey 5-Star Trader,

Wow! It’s only Thursday, but it’s already been a very long week. This week, we had so many topics in focus, from my long list of earnings destruction candidates to the critical levels in market-leading stock I was eyeing, to the daily new lows for the year in the S&P and Nasdaq. 

Sitting here, only partly through the week, I can tell you that trading earnings destruction has been my go-to setup in this market. The few stocks on the list that didn’t fall on earnings, Roblox (RBLX) and Yeti (YETI), to name a few, managed initial rallies but so far, it doesn’t appear those rallies will change the course of action in these stocks. 

This is why I’ve adjusted my earnings strategy a bit this quarter, especially down on market lows. While earnings destruction is a great setup, traders do need to be cautious of trying to short market lows. While many of these stocks are more likely to go bankrupt than ever see all-time highs again, we have to keep in mind that at market lows, the put/call is high, and short interest, especially in some names like Beyond Meat (BYND), can get a trader caught on the wrong side of a massive short squeeze! 

On Wednesday, Kelly Evans and I discussed three earnings tickers with short potential, including BYND, Disney (DIS), and Rivian (RIVN) as well. As I noted in the segment, I like all three to the downside, but at new lows, it’s challenging to get an entry point to the downside and be right. Generally, if I want to be conservative on earnings, I’ll sell either credit spreads (if I’m betting on a direction) or an at-the-money iron condor (if I’m making a neutral bet). However, this quarter, I’ve been buying puts more often. 

But, instead of just using the earnings season, I’ve started using further dated options strategies, especially when buying at the money puts. This does a couple of things, like give me more time, but it also can counteract the vol crush that occurs on earnings.

Now, I will warn you, that in any other market condition, buying long options, either calls or puts, prior to earnings is usually a bad idea. This is because implied volatility rises going into earnings, which increases the cost basis of the option. When the earnings event occurs, that volatility gets crushed, meaning the price of the option will go down. The only way to counteract the negative impact on a long option that gets hit by vol crush is to either go further out in time and/or see the price of the stock experience something like a twice the expected move to the downside. This is because options are priced so that if the ticker makes a ‘market maker expected move,’ the buyer of the long option would lose money, simply because of the time decay and vol crush. With a move that is greater than expected (for example, if the market makers are pricing in a $5 move and the stock falls $10), this is when those puts you purchased would really get juicy.

So, what does that mean? It means that two things can be true – I can be bearish on a company prior to earnings, but I can also think buying puts is not a good idea. If you want to buy puts, you should know you’re betting on total earnings destruction – a move at least twice what is expected. Think, of Teladoc (TDOC), Netflix (NFLX), Upstart (UPST), or countless others this quarter. 

What happens if you don’t want to risk the premium of the long puts? Well, just know you must risk the full premium on any earnings trade because taking a stop isn’t something that is possible most of the time. If you don’t want to risk the premium, then selling premium, the higher probability bet is the place to focus. Because of the rise (and subsequent fall in IV) that occurs on earnings, selling call credit spreads, put credit spreads, or iron condors are also viable strategies. 

As I said, the week isn’t over yet. There are still more companies reporting this week, in addition to a new slew of companies next week. Make sure you check out and follow me on Twitter, where I’ll post next week’s list of my favorite Earnings Destruction candidates! 

I have a feeling the craziness won’t be over anytime soon!

-Danielle =)

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