In most malls, you can take an elevator down to save some time during holiday shopping mayhem. In the stock market, the adage "Stocks take an escalator up and an elevator down" still rings true. Especially for growth stocks that have chugged higher for months or years.
XThat's why the weekly Earnings Preview column has been highlighting the use of carefully selected call options as a low-risk alternative to purchasing shares just ahead of quarterly results.
And as we see regularly, earnings news can truly make or break an uptrend.
Just look at what happened to Nordstrom (JWN) this past week.
The department store chain's shares collapsed 29% and hit a 52-week low even after it reported a healthy 86% rise in October-quarter earnings on an 18% sales increase. Casual clothing retail giant Gap (GPS) cratered 24% in the heaviest single-day turnover in more than a year on its quarterly results.
This week, we focus on Five Below (FIVE) and Hibbett Sports (HIBB) in the retailing space.
Growth Stocks In Retailing Today
Five Below is currently crafting a 13-week cup with handle. This pattern has proved to generate huge gains — especially when all of the other key factors of CAN SLIM investing are in place.
At this point, the proper time to buy shares would be when FIVE rises past 221.10, or a dime above the handle's highest price of 221.
The handle began forming after the midcap growth stock and specialist in popular goods priced $5 or less hit a near-term high of 221 on Nov. 16. Good handles show a mini-shakeout of uncommitted investors ahead of a potential breakout. Notice in Five Below's case, the handle slants lower, as a good shakeout should.
The handle's midpoint of 212.29 surpasses the cup's midpoint of 201.56. Also, good. This means FIVE has worked hard in carving the right side of the base and scaling past an overhead supply of disgruntled sellers who bought at higher prices and on the way down.
How To Trade Growth Stocks On Earnings With Call Options
As of Friday's close, the Dec. 17 monthly call option on FIVE stock with a 220 strike price was at 6.10. So, buying one call option to control 100 shares would cost $610. That equals just 3% of the cost to buy 100 shares at Friday's closing price of 204.74. Relatively inexpensive. Why? Suppose you bought those 100 shares, and Five Below tumbles on its Dec. 1 report. A 5% drop would result in a paper loss of $1,023.70, if you bought the stock outright. A 10% decline? You're $2,047.40 in the hole.
And just imagine what a 15% plunge or 20% thrashing would do to your account. But no matter how bad the stock drops, your risk on the option is capped at the $610 cost.
But what about your upside potential? If FIVE rises bullishly on its report, it would still have to rise to at least 226.10 for the trade to begin making money. That's assuming you choose to exercise the option and take possession of the shares, which is our goal.
How could you reduce that breakeven threshold? The 215 call closed Friday with the bid at 7.40 and the ask at 8.40 at the same expiration. That's a pretty big spread and shows less liquidity. There is only one contract of open interest and it had no trades on Friday. Assuming you could get it between the bid and ask at 7.90, Five Below would have to reach 222.90 by Dec. 17 for this earnings call option trade to get in the green for your exercised option.
Five Below also trades weekly options. The Dec. 10-expiring 220 call shows its only trade on Friday at $5.60; the Dec. 3 220 call had its only trade at 4.25.
Analysts polled by Thomson Reuters see the Philadelphia-based retailer posting earnings of 29 cents a share, down 19% vs. a year ago. In the fiscal third quarter a year earlier, earnings jumped 100% to 36 cents. They also expect sales in the just-ended October quarter to rise 18% vs. a year ago, to $562.2 million. That would follow increases of 26%, 25%, 198% and 52% in the prior four quarters.
Will Hibbett Sport A Muscular Breakout?
Hibbett, meanwhile, has reversed sharply lower after trying to take out its 100.42 buy point in a cup without handle. A single Dec. 17 monthly call at 100 traded around 3.21 on Friday, good for a 3.6% risk vs. buying 100 shares outright. The sporting goods chain does not trade weekly options. But with the stock trading just below 88, you need more than a 13% jump in price just to get that option in the money.
Wall Street sees the Birmingham, Ala., firm's profit rising 10% to $1.59 a share on a modest 8% sales gain to $359.3 million. A year ago, Q3 earnings soared 353% on a 20% top-line jump.
Among other growth stocks in the retail field, Roger Federer-backed Swiss footwear firm On Holding (ONON) recently showed the power of the earnings call strategy.
When On joined Leaderboard as an earnings option play, the December 40 call showed a premium of $1.75 at the midpoint. After Q3 results hit the wires, shares spiked past a 39.90 cup-with-handle buy point of 39.90. The 40 call on Nov. 17 hit as high as 16, or up 814%.
Options Trading Strategy For Q3 Earnings Season
A basic options trading strategy around earnings using call options allows you to buy hot growth stocks at a predetermined price without taking a lot of risk. Here's how the options trading strategy works:
First, identify top-rated stocks with bullish charts. Some might be setting up in sound early-stage bases on strong Q3 earnings. Others might already have broken out and are getting support at their 10-week line for the first time. Some might be trading tightly near highs and refusing to give up much ground. Avoid extended stocks that are too far past proper entry points.
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In options trading, a call option is a bullish bet on a stock. Put options are bearish bets. One call option contract gives the holder the right to buy 100 shares of a stock at a specified price, known as the strike price. A put option gives the holder the right to sell 100 shares of a stock at a specified price. You earn profits when the stock falls below the strike price with a put option.
Check Strike Prices
Once you've identified some bullish earnings setups for a call option, check strike prices with your brokerage. Make sure the option is liquid, with a relatively tight spread between the bid and ask. Look for a strike price just above the underlying stock price (out of the money) and check the premium. The premium ideally should not exceed 4% of the underlying stock price at the time. In some cases, an in-the-money strike price is OK as long as the premium isn't too expensive.
Choose an expiration date that fits your risk objective, but keep in mind that time is money in the options market. Near-term expiration dates will have cheaper premiums than those further out. Buying time in the options market comes at a higher cost.
This options trading strategy lets you capitalize on a bullish earnings report without taking too much risk. Risk is equal to the cost of the option. If the stock gaps down on earnings, the most that can be lost is the amount paid for the contract.
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Put options are for weak performers with bearish charts. The only difference is that an out-of-the-money strike price is just below the underlying stock price.
Please follow Chung on Twitter: @saitochung and @IBD_DChung
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