Fourth-quarter earnings season isn't in full motion yet, but reports are starting to roll in that merit attention for traders.
In a rising interest-rate environment that's fueled some stiff selling in the bond market lately, financials, including online broker s, have been reaping the rewards. Higher rates generally mean improved earnings for financial stocks.
[ibd-display-video id=3037819 width=50 float=left autostart=true] Results from Interactive Brokers ( IBKR ) will be out Tuesday after the close. The stock was a standout performer in 2017, up 62% compared with a 19.4% gain for the S&P 500. After a period of soft sales in 2016 and the first quarter of 2017, sales growth has accelerated for two quarters, from 13% to 33%.
The online broker was trading tightly near the 10-week moving average after an impressive breakout in late July over a 39.78 buy point. It's a possible candidate for a call-option trade due to support at the 10-week line, although the stock was borderline extended late in the week.
IBD's option strategy is a way to minimize risk around earnings. Rather than buy a stock outright ahead of earnings and run the risk of getting hurt by a bearish gap down in price, a call-option contract allows you to participate in a stock's advance post-earnings without risking a lot of capital. Ideally on a bullish earnings report, you can exercise the option, take control of the shares and hold them for an extended advance.
Remember that call options should only be used with technically healthy stocks that are near buy points. Extended stocks too far past proper buy points should be avoided. Call options are bullish bets on a stock; put options are bearish bets.
Let's see what a call-option trade recently looked like for Interactive Brokers. When shares were trading around 62.25, a monthly call option with an out-of-the-money strike price of 65 was selling for around 0.45, offering a trade with paltry downside risk of less than 1% (0.45/62.25). Keep in mind that the stock would have to rally over 65.45 just for the trade to start making money.
In the above scenario, the contract gave the holder the right, but not the obligation, to buy 100 shares of Interactive Brokers at 65 for a cost of 45 bucks, excluding commission. The maximum amount that could be lost on this trade was $45, the amount paid for the contract.
While slightly out-of-the-money strike prices should be targeted, where the strike price is just above the underlying stock price, sometimes in-the-money strikes can be OK. In this case, the 60 strike price offered a pricey premium of $2.80, presenting a trade with elevated downside risk of 4.5%. Always look for trades with downside risk of 4% or less.
Interactive Brokers is a good example of how option strike prices can, at times, be too far apart for a trade to makes sense. That's why in-the-money strike prices are OK, so long as the premium is reasonably priced.
IBD 50 Software leader Atlassian ( TEAM ) reports Thursday after the close. It's near highs as it works on a cup-shaped base with a 53.55 entry, although it could try to form a handle that would give an earlier entry.
Atlassian's situation is like Interactive Brokers' due to strike prices that are spread out. When shares were trading around 51.75, a slightly out-of-the-money monthly call option with a 55 strike price (Jan. 19 expiration) came with a premium of around $1.25, offering a trade with manageable downside risk of 2.4%. But again, Atlassian would have to rally over 56.25 for the trade to start making money, a potentially tall order.
Chip-equipment firm ASML Holding ( ASML ) plans to report Wednesday before the open. Leadership is broad in the group, which includes other top-rated names like Lam Research ( LRCX ) and Applied Materials ( AMAT ), although both names are struggling at their 50-day moving averages after signs of institutional selling started to appear in late November.
In the latest week, Delta Air Lines (DAL) offered up a tempting trade ahead of its earnings report Thursday before the open. Late Wednesday, when shares were trading around 55.50, a weekly call option with a 56 strike price (Jan. 12 expiration) came with a 0.75 premium, offering a trade with limited downside risk of 1.4%. Delta delivered solid earnings and a nice outlook, fueling a 4.8% gain for the stock Thursday.