The debate in Washington with respect to the debt ceiling has resulted in a market that is very difficult to navigate. Stocks this week drifted lower and are poised to finish the week with a loss of 4%. Within that overall negative environment companies reporting earnings traded mostly in relation to specific news instead of outside noise.
The best way to go in this environment is to trade earnings. The beauty of trading earnings then is that you can get a fairly predictable response to earnings reports without having to worry about outside interference. The trick of course is being adept at predicting results.
Of course there are some rules that need to be followed diligently in order to maximize my approach. For example, when a trade goes awry, exiting the trade quickly can preserve capital and minimize losses. Utilizing the extended trading is well worth the expense in order to exit a position.
Earnings are typically released before the market opens or after the market closes. Those trading earnings can then compare actual results to expectations. If you are wrong with your analysis, selling immediately is the best thing to do even if the regular market is closed.
A good example of how this works came in to play this week with Delta Airlines (DAL).
This past week I recommended trading Delta Airlines in advance of its earnings report. Shares had sold off significantly since its last report. The thinking was that meeting expectations or even better beating estimates would trigger a big rally in the stock being that shares were oversold.
The risk of course is that such a call was swimming against the tide. In the prior week several airline companies released earnings. All shared a similar theme in that earnings missed expectations due specifically to the increased cost of jet fuel.
In the last quarter, Delta experienced similar cost pressure and managed to beat expectations. Shares of the stock were trading at $9 per share at the time and rallied some 20% in the days following the report.
This time around shares of Delta dipped to $8 per share offering compelling value should the news be better than expected.
With oil hovering around $100 per barrel, airline stocks including Delta were slammed in the weeks before Delta was set to report results. From the end of June to the closing price prior to Delta announcing earnings, shares of Delta were down more than 12%. That selling created a coiled spring assuming a strong report.
In the last quarter Delta reported results that beat expectations by a wide margin. The company lost 38 cents per share. Wall Street was calling for a loss of 51 cents per share. Over the last 90 the average estimate for the second quarter fell giving the company more cushion with respect to actual numbers. The estimate for the second quarter was for a profit of 46 cents per share.
I called for my earnings trading service subscribers (shoot me an e-mail to [email protected] for more information) with Delta trading for $8 per share.
The Exit and Outcome
Shares of Delta were fairly steady around the $8 mark prior to releasing earnings on Wednesday. On Tuesday the stock closed at $8.02 per share. I viewed the firmness in price to be a positive. I was wrong. Like a broken record, Delta reported results on Wednesday morning that missed estimates. Delta blamed higher jet fuel costs for the miss.
Without a strong report the possibility of move higher was null and void. As such I immediately instructed subscribers to close the position at the open of trading. I expected a lower open for Delta based on the disappointment.
Subscribers were able to sell shares at $7.84 per share.
Shares of Delta did indeed open lower and collapsed from there. The stock touched $7.30 per share significantly lower than our exit price. The stock did rebound from there to close at $7.61. By selling at the open, earnings traders saved 13 cents per share. That may not seem like much, but cutting your losses by as much as possible is always a good thing.
We could have saved more money by utilizing the pre-market. In fact the initial reaction to the Delta report was muted. The earnings report was only a slight miss and given the huge sell-off investors held firm in the minutes after Delta issued the news.
The lesson from this trade is to be disciplined with your selling when a report comes out counter to your analysis. When companies miss earnings estimates the market tends to be unforgiving especially in that first day of trading after the news.
While it is entirely possible to endure the losses and wait for an eventual recovery, the idea behind trading earnings is to get in and get out. Traders that use earnings are looking to capture big gains quickly. When those gains fail to materialize it is time to sell.
Not every trade will work out. They all don’t have to work to be very successful trading earnings. What matters is being able to cut your losses when a trade doesn’t work.
If you are interested in joining us for the remaining 5 weeks of trading, feel free to drop me an e-mail at [email protected].