Date Published: 2017-08-13
PREFACE
There is a bullish momentum pattern in Broadcom Limited (NASDAQ:AVGO) stock 6 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market.
The strategy won't work forever, and in fact, it has won as often as it has lost over the last year, but since the winning trades are so much larger than the losing trades, it has returned 444% over the last 3-years and 22% over the last year
LOGIC
In a bull market there can be a stock rise ahead of earnings on optimism, or upward momentum, that sets in the one-week before an earnings date. Now we can see it in Broadcom Limited.
The Bullish Option Trade Before Earnings in Broadcom Limited
We will examine the outcome of getting long a call option (with two-weeks to expiry) in Broadcom Limited 6 days before earnings (using calendar days) and selling the call before the earnings announcement.
Here's the set-up in great clarity; again, note that the trade closes before earnings, so this trade does not make a bet on the earnings result because AVGO reports earnings after the close of trading on its earnings day (projected as 8-24-2017 by NASDAQ)
6 calendar days before 8-24-2017 would be 8-18-2017.
Risk Control
We will test a strict risk control which imposes a 50% stop loss and a 50% limit gain. Here is that set up:
In English, if at any point the long call loses half of its value, the trade was closed, attempting to avoid a total loss. At the same time, if the long call rises 50% in value at any tine, then it was also closed to lock in the gain. This stop and limit could trigger the trade to close before the final day.
Here are the results over the last three-years in Broadcom Limited:
We see a 444% return, testing this over the last 12 earnings dates in Broadcom Limited. That's a total of just 84 days (7-days for each earnings date, over 12 earnings dates). This has been the results of following the trend of bullish sentiment into earnings while avoiding the actual earnings result.
We can also see that this strategy hasn't been a winner all the time, rather it has won 10 times and lost 2 times, for a 83% win-rate
The trade will lose sometimes, but over the recent trading history, this momentum and optimism options trade has won ahead of earnings.
Setting Expectations
While this strategy had an overall return of 444%, the trade details keep us in bounds with expectations:
- The average percent return per trade was 30.8%.
- The average percent return per winning trade was 43.9%.
- The average percent return per winning trade was -34.6%.
A PERFORMANCE NOTE
For quite some time in the past and even the very recent history, these pre-earnings momentum investments have been winners. We saw them explicitly in just the last few weeks in Alphabet (GOOGL), Marriott (MAR) and just last week in Nvidia (NVDA). But, if we look at the most recent year for AVGO, the trade actually hasn't been overwhelmingly good:
With the recent market turbulence, a straight down the middle bullish bet could get derailed by exogenous forces that, while they are not stock market specific, are just as disruptive and could push a loss trigger quickly.
But, for a fuller view, AVGO is one of the leading technology companies and has seen its stock follow the bullish pattern that much of mega tech has seen. Here is a two-year stock return chart with AVGO in red and the Nasdaq 100 (QQQ) in yellow.
This is one of those set-ups were the win-rate over the long-run is higher than the lose rate, and the size of the winning trades (in percent) is also larger than the losing trades, but, it's a probability play, not a sure thing. Having said that, GOOGL, MAR, and NVDA have left a nice backdrop.
WHAT HAPPENED
Bull markets tend to create optimism, whether it's deserved or not. This has been a tradable phenomenon in Broadcom. To see how to test this for any stock we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work
Risk Disclosure
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.