For an archive of The Daily Breakdown’s 5-Day Bootcamp, see the guide below:
Bootcamp Day 1: Picking a strategy
Bootcamp Day 2: Every strategy has a time and place
Bootcamp Day 3: Position sizing
Bootcamp Day 4: Trading around big events
Bootcamp Day 5: What to do during corrections
When investing in specific stocks, one consideration has to be the events calendar. Big events have the potential to cause big movements — both favorable and unfavorable for our portfolios.
Many times, we already know about these events and when they are…we just don’t know what the outcome will be. For instance, think of events like earnings. Other times, these events are unknown, like an unexpected update from management or an investigation from a regulator.
To some degree, the only way we can somewhat prepare for unexpected events is by conservative position sizing, but it’s a truly difficult balance to get right and sometimes it can simply boil down to luck.
Known events (like earnings)
When we know a key event like earnings is just around the corner, we have to prepare for that.
For long-term investors, earnings are just a part of being a long-term holder — good or bad. While investors can change their mind on an investment at any time, earnings are inevitably part of the ride for those that plan to hold for months or years at a time.
For short-term active investors though, they really need to decide if they want to be exposed to a particular stock ahead of an event like earnings, and if they do, they have to decide how much exposure they want going into the event.
Oftentimes traders will opt not to trade a stock into the event, even if the setup fits their strategy otherwise. The reason why is simple: Risk management.
Risk management is paramount to a trader’s success or failure. But because the event has an unknown outcome, the risk is technically unknown. So short-term active investors should be aware of a company’s upcoming events and decide if they want that added risk or not.
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Dealing with the risk
For those that opt to have exposure to a stock into an event like earnings, there are two ways to consider the approach.
Take our XYZ example from the other day. With shares trading near $20 apiece, say the trader is bullish but sees that earnings are coming up soon. Instead of taking a $2,000 position with 100 shares, that investor might opt to cut the position down to say 20 shares, for example. The smaller position size will help shelter them from some of the potential volatility while also allowing the investor to have exposure to the stock.
Another option could be options — no pun intended.
Trading options around earnings is not easy. Because of elevated volatility levels, the price of these options are more expensive as well. However, investors who buy calls or puts pay what’s called a “net debit.” In these types of scenarios, the net debit is the trader’s maximum risk in the trade.
So sticking with our XYZ example, say the $21 call is trading for $100.
The maximum loss for the options trader in this scenario is the $100 they paid for the option. However, if shares of XYZ move in the investor’s desired direction, they can reap the reward of having exposure. But make no mistake about it: The main benefit here is defining our maximum risk.
We still don’t know the outcome of the trade, but by defining our risk, we know the worst-case scenario of the risk, and that’s a big component to long-term successful trading.
All this to say that investors may still opt to avoid a stock or ETF ahead of a specific event and that’s fine risk management, too.
For those looking to learn more about options, consider visiting the eToro Academy.