When it comes to trading a company's upcoming earnings one of my favorite options strategies to employ is a strangle. The strangle is the purchase of a call and put and where an investor expects a decent move to the upside or downside to profit from. When using a non-directional strategy (straddle, strangle and reverse iron condor) traders do not need to be concerned about what the particular company reports, but weather earnings will be a catalyst for future gains and or losses for a company's stock price.
While any trader can speculate on a company using non-directional strategies, I prefer to use non-directional strategies near earnings. A company's earnings can be a strong catalyst to further upside or downside and by using a non-directional strategy you get to play on both sides of the fence without making a one-sided bet. When considering trading a company's earnings using non-directional strategies one factor to consider is looking at probability of success. Some stocks show a pattern of success using non-directional strategies and others don't. In 2012 Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) were favorites of mine using non-directional strategies and proved successful. Please read here and here.
I enjoyed trading non-directional strategies on Home Depot and Lowe's since they have similar business models and a bullish housing market generally benefits both of these stocks. My thesis for trading non-directional options (strangle) was that both Home Depot and Lowe's were constantly making new highs and any a sub-par earnings report could spur selling. Having a thesis that matches probability of success can be helpful to validate where a certain stock is heading to and achieve desirable returns.
One stock to consider using a non-directional strategy on is Teradyne (NYSE:TER). Teradyne is a global supplier of automatic test equipment that tests semi-conductors for commercial, defense and aerospace customers globally. The company has three main components that are semi-conductor, systems test group and wireless test segment. The semi-conductor sector has been modest with only a 4% gain in the last three months, while Teradyne has enjoyed an over 20% gain in three months. When taking a quick glance at Teradyne traders will notice that the company has a history of making positive earnings surprises. In fact the last eight earnings reports have been positive earnings surprises reported for the company. Now just because a company has a history of been beating earnings doesn't mean the price of the stock will only move one way. When taking a look at a chart of Teradyne below investors will notice that Teradyne has seen upward bullish momentum since October 2012 and has done well when bought on dips.
Traders should also notice that Teradyne has struggled with the mid $17 level since February 2012 and the stock has tried unsuccessfully getting through the mid $17 level on February 16, March 27, April 27 and most recently January 2, 2013. With earnings coming right around the corner this may be the time (or not) that Teradyne either breaks higher or lower and here are some reasons to consider strangling Teradyne's upcoming earnings.
1) Teradyne can be viewed as a seasonal stock where the first and second quarters typically show strong semi test orders and the third/fourth quarters being lower. China is a big source of revenue for Teradyne and any decline in revenue can hurt the company.
2) Look for Teradyne to continue to use their balanced cash position for growth, research & development and acquisitions rather than paying a dividend.
3) Gross margins for Teradyne for Q3 came in at 56.2% compared to 56.8% for Q2 2012. I would expect gross margins to stay around the same level for the upcoming quarter, but a decline in net bookings could signal a short term top in gross margins.
4) If traders used a strangle on Teradyne's last three earnings reports these have produced a decent profit (examples below).
October 25, 2012 Q3 earnings: On October 23, 2012 buy the (Nov 14 call/13 put) strangle for .79 On November 12, 2012 traders could have closed out this strangle for $1.70 and pocketed $91 profit per strangle.
July 26, 2012 Q2 earnings: On July 15, 2012 buy (Aug 14 call/13 put) strangle for $1.05 On August 16, 2012 traders could have closed out this strangle for 1.925 or $87 profit per strangle.
April 26, 2012 Q1 earnings: On April 16, 2012 buy (May 17 call/16 put) strangle for $1.22 On May 18 traders could have closed out the trade for $1.67 or $45 profit per strangle.
On January 14, 2012 I purchased the February 17/16 strangle for $1.05 With Teradyne not currently able to break through the $17 and if earnings fail to act as a catalyst the stock in the short term could dip down to the mid $15 level. However, on the other side Teradyne could give a good earnings forecast that might allow the shares to break $17 and continue making gains in 2013. Over Teradyne's last three earnings the stock has made some significant moves with at least a minimal of 12% price movement (up and down).
Buy (1) February 17 call for 0.60 (0.60 x 100= $60)
Buy (1) February 16 put for 0,45 (0.45 x 100 = $45)
60 + 45 = $105 cost for February strangle
Days till expiration 31
In conclusion, past performance doesn't mean the future will automatically bring profit on a non-directional strategy going into earnings. If Teradyne can't get through the $17 level I could see the stock dip into the mid $15 range. The mid $15 range is also the breakeven point for the put-side of this trade idea. With Teradyne's technical set-up and with earnings right around the corner I don't mind speculating for around $1.00
Thanks for reading and good luck.
Disclosure: I am long TER.
Additional disclosure: I own the Feb $Ter 17/16 strangle