The Earnings Plight

One thing that we have to pay attention to when we trade is earnings. I haven’t mentioned it very much on here, because I tend to trade ETFs (which don’t have earnings, most of the time), so I normally don’t worry about it too much.

But when we have active positions in single stocks, it’s something that we definitely need to keep on the radar.

When it comes to earnings, a lot has to do with the sentiment of the marketplace. An expected earnings per share is normally announced in advance, and how the actual earnings matches up with that determines how the market reacts. If the company completely misses its target EPS, the market doesn’t really like that, and the stock tends to dip.

But, the market also likes to play little tricks of its own. Sometimes, the stock can competently overshoot its estimated EPS, delivering really high earnings, and the stock still might dip. There are many different reasons for this, the main one being that investors might see that the company is being inefficient with its overall income.

See, earnings per share is calculated as (net income – dividends / # of shares OS). So 2 companies could theoretically have the same EPS, but on could do it with less investment or effort than the other, making it the better company.

But really, earnings are kind of random. That’s not a great thing to say, but there are so many different things going on the marketplace during each earnings cycle, so we can never really predict how investors will react to an announcement, whether the company misses or hits its goal.

Earnings are volatile. Sometimes, the EPS will be positive, and the stock will respond favorably, but a few hours later, it will dip in price (look at NVDA’s recent run for a prime example). So we can’t really predict anything off of a strong earnings per share OR a weak earnings per share.

Which really isn’t that fun.

However, we can take advantage of volatility. Because earnings are a binary event, and generate uncertainty, volatility tends to increase. We can move in and place a trade that profits from the eventual volatility crush, or decrease.

These trades tend to be risky, and require a bit more capital. Also, there is a chance that they can go terribly wrong. I tend to stay away from trading earnings, but a lot of people live for these types of trades (check out this show if you want to  learn more).

Overall, earnings can be a great place to collect some vol, but we have to be careful with how much risk that we take on.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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