Gear up for Earnings Cycle Profits

By Ken Trester

If it's simply a case of seasonal weakness, use Wall Street's short-term memory loss to buy call options for companies that will see a seasonal earnings recovery in the upcoming quarters. For instance, if retailers aren't doing very well during the summer months, going into the holiday shopping season you may want to choose specific names or invest in the sector itself through an exchange-traded fund (ETF) such as the Retail HOLDRs (RTH), which represents nearly 20 names in that industry.

RTH is one of many optionable ETFs available to trade when you want to invest in an industry rather than a number of individual names. This strategy can not only save you commission costs, but it could also protect you against "overweighting" your portfolio with too many names in one sector.

Conversely, if a company greatly surpasses estimates, investors can also punish the stock by selling. It may seem counter-intuitive, but many investors worry that a blowout report means the company has hit an earnings apex and will be unable to sustain such high numbers in upcoming quarters.

Again, check to see whether the company has cyclical earnings, or if it enjoyed an exceptional one-time boost from the sale of a holding or a new product launch, for example. If that's the case, it's likely that the next quarter's earnings will also be strong, so it can pay to buy call options at a discount.

Either way, it's difficult for options traders to use earnings surprises to time the purchase or sale of options. You may be more successful if you use forward-looking information and forecasts from earnings reports to set up your longer-term options plays with Long-Term Equity Anticipation Securities, or LEAPS.

Generally, establishing an options position at least three weeks prior to an earnings announcement will ensure you get in before any pre-announcement news potentially inflates the options premium.

Knowing when to sell, however, is a bit trickier.

If an option's value suddenly plummets after an earnings announcement, the amount of time left before expirations will be the key to determining your next move. If there's at least three months until expiration, you may benefit from holding the option to see whether it will recover. Otherwise, you may be better-served to bail out of a losing position to quell losses and recoup any remaining value while it still exists.

Earnings season can bring with it a bevy of buying opportunities, as well as discount delusions -- just remember that what looks to be a good deal isn't always one. Be sure to look at the time premium available for each option and take advantage of a company's earnings forecasts for upcoming quarters.

Ken Trester is Editor of Fast Options Profits.