Trading Intuitive Surgical's Upcoming Earnings Call

Oct. 6.11 | About: Intuitive Surgical, (ISRG)

I am always careful as to what stocks I will trade around the time of their earnings release. I can't tell you how many stories I've heard over the years (including my own in the early days) from options traders that have made the mistake of placing trades that hope to capitalize on a big move in the stock price, only to realize that the stock simply doesn't move enough to justify the trade. Unfortunately, they took big losses on those trades.

When this type of situation happens with beginners, they usually get frustrated and give up trading options much too soon. However, if a person does his / her homework on which stocks work well with this strategy, options can provide amazing returns.

This article will include some information on the company and a chart on its previous earnings price before reporting earnings and then the post-earnings price. Since I am delta neutral on this company (i.e. I do not care which direction the stock moves as long as it makes a significant one), I buy both call and put options that are out-of-the-money on both sides of the trade.

The strategy I implement is called an Option Strangle (Long Strangle). I like to buy the calls and put options at least one month out so time decay doesn't deteriorate the price of the options once the earnings are released. I do not recommend using this strategy with weekly options or options with little time-value left. The implied volatility will drop substantially after earnings announcements, which in turn can hurt the price of your option. I can't stress that enough.

One of the advantages of this trade is that it requires a lot less capital to place the trade (because the calls and puts are out-of-the-money), while still reaping the benefits of the large swing Intuitive Surgical's (NASDAQ:ISRG) earnings provide. The leverage options makes this trade well worth it. It should also be noted that I do not intend to exercise any of these options to own the stock. More often than not, I will sell the call or put (whichever is profitable) the next day after the earnings release. However, the choice of when to sell the position is up to the trader.

Now that the strategy is laid out, let's get to the company itself. Intuitive Surgical , which is preliminary scheduled to report earnings on Tuesday, October 18, 2011 after the market closes, designs, manufactures, and markets da Vinci surgical systems for various surgical procedures, including urologic, gynecologic, cardiothoracic, general, and head and neck surgeries. Its da Vinci surgical system consists of a surgeon's console or consoles, a patient-side cart, a 3-D vision system, and proprietary wristed instruments. The stock closed Tuesday at $364.03. ISRG has a 52-week price range of $246.05 - $415.19. It also has a beta of 1.74. This stock makes very large moves after earnings. However, it is also very volatile on regular market days, as well.

Here is a chart of the company'sr last earnings release on July 19, 2011:

Date Open High Low Close Volume Adj. Cl.

Jul 20, 2011 392.12 407.00 392.12 397.47 1,325,800 397.47
Jul 19, 2011 365.91 375.99 365.05 374.90 676,100 374.90
Jul 18, 2011 357.23 362.99 353.39 362.28 268,700 362.28
Click to enlarge

As you can see from the above chart, the day before earnings the stock traded as low as $353.39 to a high of $407.00 one day after earnings. That is an explosive 15.1% move for a stock that trades as high as ISRG does.

Intuitive Surgical (ISRG) is a great stock to play using options, but especially the Options Strangle strategy. I am always comfortable purchasing these out-of-the-money (OTM) contracts with strike prices that are anywhere from $30-$50 away from where it trades at going into earnings on both sides of the trade (calls and puts). As stated above, make sure you give yourself at least one month until the options expire. I will be buying a November 2011 strangle with 10 calls and 10 puts with strike prices of $410 (calls) and $310 (puts), respectively. I will purchase my options the day before earnings, on October 17th. The volatility is increased so close to the earnings date, but for this particular trade I really need a handle on where the stock price is currently at so I know the what strike prices I need to purchase.

A lack of liquidity with ISRG options is an issue, and there is usually a large spread between the bid / ask price. It will tighten a bit as volume increases. As I always stress when trading options, never place a market order. Always use limit orders.

A very handsome profit should await you with this trade. Remember, the point of this trade isn't to hit the exact strike price necessarily (all the better if it does). You will simply be placing the trade to profit from the large price swing and rise in the price of your options. The number of contracts purchased on the strangle is up to the trader.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ISRG over the next 72 hours.

Additional disclosure: I will be purchasing a strangle option on ISRG as mentioned in the article one day before the earnings release, preliminary due to report October 18th.