So what’s a good earnings report definition and why is it important for options traders? An earnings report is something that is required by corporations law and is the way that publicly listed companies report their earnings to shareholders.
These report typically include an income statement, a balance sheet and statement of cash flows for the quarter, as well as year to date. The notes to the report also include an analysis of company activities and financial condition, along with various risk disclosures and other matters which may affect shareholders’ interests.
Some countries such as the USA, require earnings reports on a quarterly basis, while others may only want it semi-annually. Either way, when an earnings report hits the news, it can often (but not always) trigger a dramatic reaction by the market to that company’s share price.
Most companies in the USA file their earnings reports in January, April, July and October.
When analysts look at earnings reports, they’re most interested in certain financial ratios such as “earnings per share” (EPS) and “price-earnings ratio” – and these help them decide whether to buy, hold or sell the shares in that company. Since analysts tend to work for large fund managers and brokerage firms, their combined decision making can often have an impact on the share price.
Using Earnings Reports for Options Trading
So how can our understanding of an earnings report definition help us to trade options more effectively? Well let’s think about it. We would most likely be interested in an option trading strategy that relies on large and sudden potential moves in the price action of a company stock. Since earnings reports can be the trigger for these, we simply apply the appropriate strategy as we see the report date pending.
One such strategy is called the Options Straddle. This strategy involves the simultaneous buying of the same number of both call and put option contracts, at the same strike price and with the same expiration date. The strategy relies on the underlying share price moving significantly before option expiration date – so much so, that the “winning” position will more than compensate for any loss on the “losing” position and realize an overall profit. I have personally taken straddle trades which have realized 100 percent profit and many, more than 50 percent.
You simply put on the straddle position about three weeks before the earnings report comes out and wait for the market reaction to it. You need to do it before the report, because options implied volatility tends to increase as the earnings date approaches. You can read more about it at our options straddle page.