Options Trading & Analysis

The Earnings Option Trade in Wells Fargo That Has Won for 3-Straight Years


Wells Fargo & Co (NYSE:WFC) has earnings due out on July 14, 2017 before the market opens.

 



LEDE
Wells Fargo & Co (NYSE:WFC) has earnings due out on July 14, 2017 before the market opens. And, just like our prior dossier on JPMorgan, the real opportunity with options isn't earnings -- it's right after earnings -- and we see a trade that has won three straight years without a loss, returning 154%.

The Trade After Earnings
One of our go to trade set-ups starts by asking the question if trading every month is worth it -- is it profitable -- is it worth the risk? There's an action plan that measures this exactly, and the results are powerful not just for Wells Fargo & Co(NYSE:WFC) but also for JPMorgan, where it has won for three straight years without a loss.

Let's test the idea of selling a put spread only in the month after earnings. Here's what we mean:



Our idea here is that after earnings are reported, and after the stock does all of its gymnastics, up or down, that two-days following the earnings move and for the next month, the stock is then in a quiet period.

If it gapped down -- that gap is over. If it beat earnings, the downside move is already likely muted. Here is the set-up:



More explicitly, the rules are:

Rules
* Open short put spread 2 calendar days after earnings.
* Close short put spread 30 calendar days later.
* Use the option that is closest to but greater than 35-days away from expiration.

And here are the results of implementing this much finer strategy over the last three-years:

WFC: Short 40/20 Delta Put Spread
 
% Wins: 100%
 
Wins: 11   Losses: 0
 
% Return:  154% 

Tap Here to See the Actual Back-test


We see a 154% winner that only traded the month following earnings and took no risk at all other times. The trade has won all 11 of the last 11 earnings cycles times, or a 100% win-rate.

Here is how the strategy has done over the last year:

WFC: Short 40/20 Delta Put Spread
 
% Wins: 100%
 
Wins: 4   Losses: 0
 
% Return:  103% 

Tap Here to See the Actual Back-test


Now we a 103% return on just four full months of trading.

Here's what we see over the last six-months:

WFC: Short 40/20 Delta Put Spread
 
% Wins: 100%
 
Wins: 2   Losses: 0
 
% Return:  44.3% 

Tap Here to See the Actual Back-test


Now we see a 44.3% return over the last two earnings cycles, winning both times.

The results are incredibly consistent, so much so that we need to take a step back and still examine the potential pitfalls here.

NO GUARANTEES
There are no guarantees to this trade, but it does appear to a very high probability investment, but even as such, it does have some drawbacks. If we look at the trade six-months ago in this back-test, we actually tested this trade (January 2017):



That is, selling a 52.5/50 put spread @ $0.56. This trade, as constructed, had a maximum win amount of $0.56 (the credit received), but it had a maximum loss of $1.94, which is the difference in the strikes (52.50 - 50) minus the credit received ($0.56). That means the max gain: max loss ratio was about 1:4.

And yes, the trade worked out well, closing that February for $0.02. But, we do, at the very least, need to be aware of the trade we are examining.

TAKING RISK OFF
One clever way to get that max profit: max loss ratio back to something more manageable, is to put in a stop loss at the exact amount of credit we received. In Trade Machine, the way to test this is to put in a 100% stop loss, like this:



In English, if we took that same trade from January 2017, and put a stop loss in at $1.12 (which is a 100% loss relative to the $0.56 credit), then our max gain would have been $0.56 (the credit) and the max loss would have been $0.56 (the credit - stop).

All of a sudden, we have a 1:1 max gain: max loss trade, and over the last year, which was four post earnings trades, the results are identical to the trade without a stop loss. Not too shabby.

WHAT HAPPENED
This is it. This is just one of the ways people profit from the option market -- optimize returns and reduce risk. To see how to do this for any stock and for any strategy, including covered calls, with just the click of a few buttons, we welcome you to watch this quick demonstration video:
Tap Here to See the Tools at Work

Thanks for reading.

Risk Disclosure
You should read the Characteristics and Risks of Standardized Options.

Past performance is not an indication of future results.

Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.

Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.

The author has no position in Wells Fargo & Co(NYSE:WFC) as of this writing.

Back-test Link


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About Ophir Gottlieb


Mr. Gottlieb writes financial news for CML and also as a contributor to Yahoo! Finance, CNN Money, MSN Money, and before then for Marketwatch, Business Insider, TheStreet and Real Money. He has become a staple in financial TV, often times seen on the Business News Network and CBC. Mr. Gottlieb's experience includes working as an option market maker on the NYSE ARCA exchange floor (CBOE remotely), as Managing Director of Client Services and Algorithmic Trading for Livevol, Inc, and as the Managing Director and Product Manager of Quantitative Research for GMI (now MSCI). Ophir Gottlieb is inventor of the Forensic Alpha Model (FAM) and a co-inventor of Accounting and Governance Risk Model, both purchased by MSCI. FAM has been a celebrated achievement in artificial intelligence and quantitative finance that was introduced to world by the Rotman International Journal upon its completion. Mr Gottlieb's mathematics, measure theory and machine learning background stems from his graduate work at Stanford University and his time as an option market maker on the NYSE and CBOE exchange floors. He has been cited by various financial media including Reuters, Bloomberg, Wall St. Journal, Dow Jones Newswire and through re-publications in Barron's, Forbes, SF Chronicle, Chicago Tribune and Miami Herald and is often seen on financial television.

Author's web site: http://bit.ly/2mnZAmV


View Ophir Gottlieb's post archive >

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Your source for the most important news and information from the world of options.

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The Options Insider Radio Network

All of our radio programs in one convenient place.

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This high-octane program features education, analysis, strategies and unusual activity.

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The Long And Short Of Futures Options

Your source for futures options information.

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Arming advisors with the info necessary to manage risk.

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Options Boot Camp

Get into peak options trading shape.

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Options Insider Special Events

Compelling panel & special event recordings from the options world.

Options Insider Special Events

OIC's Wide World of Options

A dynamic mix of current events, investor resources, & strategy insights.

OIC's Wide World of Options

Trading Tech Talk

We break down all the amazing technology that takes your trades from the click of a mouse to the clearinghouse.

Trading Tech Talk

Options Playbook Radio

Break down cutting-edge options strategies and learn how to incorporate them into your portfolio

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We track all the unusual options trading activity on Options Oddities.

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