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Oracle's Going Down: How to Trade Earnings

Stocks in this article: ORCL MSFT RHT IBM AAPL HPQ

Oracle doesn't pay a large dividend like many of its peers. That's likely the result of Oracle's stock remaining resilient while others haven't.

ORCL Dividend Yield Chart ORCL Dividend Yield data by YCharts

If we all agree that Oracle is expected to crush the earnings report, how can we profit? The simplest way is obviously to buy shares. There is another strategy that I like better for the risk-averse.

Oracle is so heavily traded that option contracts are very liquid. This is especially so near an earnings release. The problem most options investors have is that they view options plays the same way as the underlying stock.

Most investors will buy a call if they believe the earnings will be good, and buy a put if they believe (or are concerned that) the stock will fall. Sounds simple enough, until you factor in what is known as implied volatility. Implied volatility is the devil that makes options relatively expensive before the earnings release, and cheap afterward.

You can be correct on the movement of the stock, and still lose money buying options. A superior method, in my opinion, is a strategy that includes a spread. While the possibilities are nearly endless, one of the most simplistic options spreads is buying one strike price and selling another.

Before we venture into which spreads may offer the best risk-to-reward opportunity, it's helpful to examine the impact previous earnings releases have had on shares.

After the September 20, 2012 release, shares moved from $32.26 to a next-day high of $33.29, before closing slightly higher at $32.47. If you timed a sale the day after earnings, you likely did very well. However, that day after was followed by three down days.

>>> September 20, 2012 Oracle Preview: Seven Earnings to Watch Next Week

Investors buying call options before the release, and who were fortunate enough to sell at or near the top, did marginally well. All other call buyers had their heads handed to them, especially if they didn't exit the following day. Put buyers didn't fare much better because of time-premium (implied volatility) evaporation, following the release.

The December 18 earnings release shares much in common with the September release. $2 higher at the peak, followed by six days of lower closes. A straight call option purchase may have resulted in a respectable gain, if closed out near the high of the day, but again, how do you know when the high is upon us? The simple answer is, you most likely don't, and that leaves much to chance.

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