Publicly traded corporations release mandatory earnings reports every quarter. These four-times-a-year news releases are often the only real news that investors can use to judge how well a company's business is going. Earnings "season" – when a lot of companies issue earnings reports – is a time when many investors make short-term trading profits based on projections of what these reports will contain. Generally, it's not necessary to trade ahead of earnings reports, and sometimes it's better to trade the stock after its report has been released.
Investors should watch for increased stock volatility when a company nears the date of its earnings reporting. Many investors trade shares at this time based upon their prediction of what will be disclosed in the earnings report.
Exploring Analyst Earnings Predictions
The earnings predictions made by Wall Street analysts tend to drive stock price action around the earnings release dates. Analysts estimate the amount of sales and profit per share that each company will report. The consensus earnings estimate is the average of analyst predictions for a specific company for the quarterly earnings period. During earnings season, traders and investors focus on how closely the reported earnings match the consensus estimates.
The earnings calendar lists when each company will release its quarterly earnings press releases. Traders focus on different stocks as the release dates approach. It's important to pay close attention to Wall Street, though, since relying solely on company news can put investors at a risk for unintentional insider trading.
Hitting or Missing on Earnings Expectations
The share price of a stock can change significantly if the company posts a "miss" compared to the Wall Street estimates. If the earnings are better than the estimate, the stock price will move higher. If the actual earnings come in close to the estimate, the share price will not move much.
Most of the earnings-related price action occurs during the trading day following an earnings release. Trading strategies for earnings seasons revolve around stocks you think will miss the consensus estimates on one side or the other. Additionally, it's important to note that businesses often deliberately understate their earnings prior to released date so that investors will feel good when their stocks come in better than expected.
Trading Based on History
One earnings trading strategy involves finding stocks for which the analysts historically do a poor job of accurately estimating sales and profits. You might find a stock whose profits have beaten the estimates for several recent quarters – a stock that moved up on the earnings release. If you think the trend will continue, buy the shares just before the earnings release and sell on the news when the price jumps.
To trade shares near the earnings release dates, you need to find stocks you have a reason to believe will be higher or lower than the estimates, but the reason should be based on history or your own analysis.
Trades for Big Price Moves
Options can let you trade against stocks when you predict a big earnings price move but do not know in which direction the share prices will go when earnings are reported. Call options let you profit from a rising share price, and puts will gain if prices fall. Buying both puts and calls gives a high probability that one side will be a winner by hedging your bets, of sorts. Known as a "straddle", this option lets you buy a stock at a certain price while also selling it a certain price by a certain expiration date.
But be careful, the options could expire without any significant movement in stock price and you could lose on both sides
Traders employ spread strategies with puts and calls to lower the trade costs and increase the potential for profits. The low cost of options means that the profit on the winning side could cover the cost of both options and leave a net profit.
Video of the Day
- Spencer Platt/Getty Images News/Getty Images