Using Pre- And Post-Earnings Options To Exit A Position

Includes: FFIV, TXN
by: Robert Weinstein

Every earnings season I become busy scanning stocks and going through the list of companies about to report looking for opportunities. It's worth the effort as I usually find several that offer a good risk versus reward. I also often come across stocks that don't necessarily offer an opportunity to me, but tend to create questions that get asked in comments and or messages.

Two stocks have gathered quite a bit of interest lately, with each one on different sides of the latest earnings release. The first one is Texas Instruments Incorporated (NYSE:TXN) and I recently wrote an earnings preview that you can read here. Texas Instruments Incorporated engages in the design and sale of semiconductors to electronics designers and manufacturers worldwide. The company was founded in 1938 and is headquartered in Dallas, Texas.

Investors of Texas Instruments have the happy problem of deciding what to do with the recent run up in price. With a trading price about $34 a share as of this writing, Texas Instruments is up about $6 off of recent lows. One common question asked is "when should I take profits?" My standard reply is "what does your written plan say?" which is almost always followed by an uncomfortable look, or reply that they don't have one.

If you fail to plan, you're planning to fail. It's an old and common saying, but it applies to trading and investing very well. Having a written plan is one of the best tools in avoiding emotional decisions with your trading. The last thing an investor wants is to have a curve ball thrown at them and try to "figure it out" on the spot. My observations over years of time in a trading chat room and from my own experience is you will make many more mistakes flying by the seat of your pants than you will simply following investment rules created before allocating capital.

Moving back to Texas Instruments, the question I was asked is when to exit. I replied asking if they have a price target and the reply was they would be a willing seller at $35. I replied back that the goal maybe was obtainable and in the mean time they could lower their risk during the waiting period. Looking at the February call options I see the $34 strike price options selling for about a dollar and the $35 strike price selling for about $0.35 each.

The question, then, is do you sell the $34 or $35 and the answer in my mind is easy. I like to mitigate and focus on risk as much as possible. Because of my concern for risk, I would pick the $34 option to write covered calls with if I had a $35 price target. Firstly, it gives me the target desired, and secondly, if the stock moves back down or simply starts to trend in the price range I get paid everyday from time decay.

The sale of options is a great way to protect what you have gained when you're close to getting out anyway. TXN trades an average of 7.5 million shares per day and the options have plenty of liquidity so there is no problem getting in and out of the stock or covered calls if the situation changes.

The second stock gathering a lot of attention for me today is F5 Networks (NASDAQ:FFIV). Unlike Texas Instruments, which is about to announce earnings, F5 just recently announced earnings that beat on revenue and bottom line profit. To add to the joy of shareholders, F5 also provided great guidance for second quarter. This news led to a rally in price sending shares up about $13 a share or about 12% over yesterday's closing price.

Similar to Texas Instruments, I have been asked when to take profits, but in this case the stock has already met the target price. In this case we can also use options to exit at possibly a slighter better price than simply selling the shares outright. Given the investor is not in a hurry and the target price is anything above $120 there is some room to work with.

Looking at the options available for the month of January, we have a special situation that can be taken advantage of. The January series expire tomorrow, and the price jumped up giving the stock lots of option liquidity below the current price. Looking at the $120 January calls I see they are trading for about $1 over intrinsic value for about $3.00 each. By selling the $120 strike January options the investor can gain an extra dollar by holding one extra day and have about $3.00 in negative price movement protection.

For a big priced stock having $3.00 in price protection may not sound like a lot and it clearly will not make sense for many. At the same time if you're not wanting to try to time the market to gain the best possible price which is often a fool's errand, this method does provide a method of exit that is both timed and possibly richer than the current market price. F5 stock doesn't need to be held through the whole day Friday to come out ahead with this strategy as well. Simply holding overnight will cause the option to experience time decay and about an hour after the opening all else being equal the option will have lost about half its value.

Using options to exit a position is not for everyone or every situation, but having another tool to work with is always better than limiting your ability to maximize your returns.

I use a proprietary blend of technical analysis, financial crowd behavior, and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner. I use Seeking Alpha, Edgar Online, and Yahoo Finance for most of my data. I use the confirmed symbols from that I believe to be of the most interest.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.