Earnings Season 24, Earnings Season With Covered Calls

Earnings season is the period that runs about two to six weeks after each calendar quarter-end. It can be quite volatile as this is when most corporate earnings are announced. You can profit from this increased volatility, and at the same time lower your risk, by using covered calls.

First and foremost let's remember that we need to be extra careful when investing in stocks that are about to release earnings. Companies can miss or exceed expected results, they can miss or exceed expectations on guidance for the future, or they can have other major announcements (change in dividend, stock split, etc). There are many reasons why a stock might move dramatically once earnings are released.

Having said that, there are ways to take advantage of the increased volatility during this season. Because option premiums are higher when volatility is higher, covered call writers have an opportunity to pocket some juicy premiums. This income lowers the risk (cost basis) of any long-term holdings they may have.

There are at least two types of earnings season covered calls: (1) writing calls on stocks you own and want to keep, and (2) writing calls on stocks you don't mind selling (including stocks you purchased just for the purpose of writing covered calls, i.e. buy-writes).

Stocks you want to keep after earnings season

For your core long-term holdings the choice of strike price is important. Rarely will you want to write at-the-money or in-the-money calls on core holdings. You're in it for the long haul and just want to take advantage of earnings season volatility to generate some extra income. Presumably you want to hold these stocks even if they miss earnings or guidance a little because you are a long term investor for these stocks.

In these cases you will usually want to write out-of-the-money (OTM) calls. That will give you room for upside in the event the company does well, reduce the chances of the stock being called away, and still give you some income. For example, here are some strike prices for stocks with upcoming earnings that are reasonable for an investor who wants to hold onto the stock even after earnings are out (for the May 21 expiration date):

Symbol Earnings
Release
Stock Price Strike Moneyness Call Bid Annualized
Return If Flat
JDSU May 4 20.00 23 15% OTM 0.38 23%
AKAM Apr 27 40.08 44 10% OTM 0.72 22%
WFR Apr 28 11.76 13 11% OTM 0.17 18%
CRM May 19 140.15 155 11% OTM 2.02 18%
VLO Apr 26 29.04 32 10% OTM 0.37 16%

Or, if you want some lower-yield examples:

Symbol Earnings
Release
Stock Price Strike Moneyness Call Bid Annualized
Return If Flat
X Apr 26 51.72 57.5 11% OTM 0.41 9.7%
CF May 9 139.26 155 11% OTM 1.01 8.5%
WFMI May 4 66.62 75 13% OTM 0.42 7.3%
M May 12 24.22 27 11% OTM 0.12 6.1%
NOV Apr 27 79.26 90 14% OTM 0.36 6.1%

Note: These are not meant to be recommendations to buy these stocks. But if you already own them then you could earn extra income if you were to write out-of-the-money calls four times per year around earnings season. Plus, you've still got at least 10% upside potential in the underlying stocks, in the event that earnings and/or guidance are good and the stock goes up after earnings are out.

Stocks you are happy to sell after earnings are out

Sometimes you want to buy stock merely for the purpose of writing a call option against it prior to an earnings announcement. Premiums are large and a buy-write seems like the right strategy. The golden rule here is: Only buy stocks you wouldn't mind holding for a while in the event that they crater below your break even price after earnings are out.

Some stocks you may want to look into for deep in-the-money (ITM) buy-writes (for the May 21 expiration) include:

Symbol Earnings
Release
Stock Price Strike Moneyness Call Bid Annualized
Return If Flat
NFLX Apr 25 252.58 225 11% ITM 32.60 28%
MWW Apr 28 17.72 16 10% ITM 2.05 25%
JDSU May 4 20.00 17 15% ITM 3.30 22%
CRM May 19 140.15 125 11% ITM 16.85 17%
AKAM Apr 27 40.08 36 10% ITM 4.55 16%

But again, it is important to stress that you should only buy these stocks after careful research and a decision to own them beyond the May 21st expiration date. It is likely they will be called away. But if they're not you want to be sure you're comfortable owning them for many months if necessary. Never do a buy-write just for the fat premium without considering the case that you could end up owning the stock for a while.

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