Cummins (CMI) , Kellogg (K) and Twitter (TWTR) all reported earnings Thursday morning and saw their shares make significant moves in reaction. The stocks will head back toward pre-earnings levels, however, and savvy traders can use stock options to profit.
Cummins reported adjusted earnings well in excess of the analyst consensus, and the stock's price gapped higher.
The chart below shows how the stock's price traded in a narrow range Thursday and Friday (doji sessions). Even so, the price remained at the upper end of the range defined by the Bollinger Bands and continued to trade above the middle band. This looks like a continuation of the current bullish trend, but you should still expect to see the gap fill at least partly. Those two doji sessions forecast a correction in coming sessions.
With this in mind, look at selling short the call options with the 150 strike price. The contracts expiring Friday closed last week with a bid of 1.25, which could be sold for $116 after trading fees. You should expect to see them open much lower on Monday.
The contracts one week prior to expiration lose 34% between Friday and Monday, on average. Based on this, look for an actual price Monday of around $82.50.
If you prefer more time for a short call option to become profitable, check the options that expire Feb. 24. The 150 call closed on Friday with a bid of 1.70. These can be sold for $161 after trading fees. Expecting some adjustment after the gap, these could be profitable in the short term. Longer term, expect Cummins to continue rising based on the chart.
Kellogg also reported better-than-expected results. The price jumped above the upper Bollinger Band and cannot be expected to remain there for long. Look for a correction back into range.
To exploit this exaggerated movement, consider buying a put option. The 75 put option that expires this Friday closed last week at an ask of 0.55, and could have been purchased for $64 after trading costs. (Expect this to decline by Monday morning based on average of 34% loss of time value the week before expiration.) The break-even level as of Friday's close was is $74.36 (strike price less cost of the put). An alternative is the 75 put option that expires March 17. This closed on Friday at an ask of 2.05, and could have been bought for $214. The break-even level is $72.86 per share.
Twitter shares slumped Thursday after the company reported a big revenue miss and disappointing guidance. Its share price declined from above the upper Bollinger Band, down to below the lower Bollinger Band. It moved from about $18.75 down to $15.58, more than three points in two days.
This big downside gap sets up an opportunity to exploit an expected reversal back into range, especially after two large gapping sessions. Consider purchasing call options. The 15.50 call that closes this Friday closed last week with an ask of 0.42, with a break-even level at $16.01.
The call options that expire Feb. 24 are much more attractive, however. They closed last week with an ask of 0.54, only 0.12 higher but offering seven more days before expiration. This offers a break-even level of $16.13 per share, a price level that looks reasonable and likely, based on the chart.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
Besides writing at TheStreet.com, Michael Thomsett also blogs at Options Money Maker, the Top Advisor's Corner at Stockcharts.com, and Seeking Alpha. He has been trading options for 35 years and has published books with Palgrave Macmillan, Wiley, FT Press and Amacom, among other publishers. Thomsett's latest book is A Technical Approach to Trend Analysis. He has recently completed a new book on options math, to be published by Palgrave Macmillan in 2017.