Corporate earnings season is upon us. With an avalanche of news and earnings reports coming out every other day for some of the biggest companies in the world, earnings season is like the Superbowl for traders. 

Newer traders might be seduced into wanting to gamble on earnings by buying shares before an earnings report comes out. As I always preach, Risk Management is key to any trade. Today, I will show you how to trade a stock with upcoming earnings responsibly and with defined risk by discussing my trade in SNAP as an example.  

Some Fundamentals

Snap Inc. (SNAP) operates as a camera company in the United States and Internationally. The company offers Snapchat, a camera application that was created to help people communicate through short videos and images. Each of those short videos or images is called a Snap.

After a poor performance post IPO in 2017, where SNAP was just burning money for a few years, it became a turnaround story. In 2019 it began to accelerate its revenue growth, and this trend has continued post-Covid, with year-on-year revenues growing quarter after quarter. 

This turnaround growth has been reflected in SNAP’s stock price. From COVID-19 lows of around $8, the stock was trading around $60 coming into this earnings report, a price gain of around 750% during this time.  

Technicals

Given that the stock had been consolidating between $50 and $70 for over six months since last December 2020, I thought it was a prime candidate for a breakout given the renewed strength in tech stocks recently.  

Daily chart of SNAP coming into its earnings report, notice the consolidation 

As classic Technical Analysis tells us, the longer the consolidation, the bigger the breakout might be. 

Furthermore, SNAP’s closest peer Facebook (FB), broke out from a similar consolidation a few months back. These types of stocks tend to trend together in harmony. Also, patterns in the market tend to repeat themselves. NVDA also broke out from a similar consolidation recently. 

FB broke out of its consolidation pattern in April

NVDA broke out of its consolidation pattern in June

All of the above factors meant that we had many factors in our favor, increasing the likelihood that our trade would go according to plan. I first started this trade a few weeks ago, on July 7th. SNAP was our bullseye trade of the week, looking to buy the $70 calls expiring July 23rd. 

However, the market didn’t make it easy for us.  Instead of running into earnings like strong stocks sometimes do, SNAP pulled back 15%, and we got stopped out on this trade. I was a little early on this one. Had we held these calls, our trade would have gone according to plan, but risk management is critical, so we took our loss and waited for a better opportunity.

Setting Up The Trade

This opportunity came a few weeks later when the trade set up again on July 16th. I was looking to sell a Put Spread as SNAP broke $60, i.e. selling the $60 puts and buying the $55 puts expiring July 30th. I was fading momentum as the stock was attractive to me at these levels, and by selling a put spread, my risk was defined. Selling put spreads is a more conservative trading strategy.

I was keeping an eye on the $60 pivot level. That was where buyers stepped into the name back in early June. And on July 20th, we got technical confirmation on our trade Idea. Here is the note from Total Alpha Updates on that day: 

Now that the stock broke the 13/30 hourly moving average, I am targeting the 200 hourly moving average for the first target level near $65. The target after this level is $70 near the recent pivot highs.

SNAP marched higher for a few days to the $63.50 area before the earnings release and then blew all expectations out of the water. It beat on the top and bottom line and received at least 12 price target increases from Wall Street analysts after they adjusted estimates/multiples following the report. 

SNAP gapped up 17.5% on the day, opening at $74.14 and making a high of $79.18. I exited the trade on this day as there was not much meat on the bone left in the put spread I had sold. My only regret is that I wasn’t bigger in this trade!

Bottom Line

Earnings season provides enormous opportunities as volatility in stocks reporting increases. We should avoid any temptation to gamble on earnings reports. Instead, we should focus on our process and continue looking for good risk/reward opportunities. We can manage our risk during earnings releases by using advanced options strategies, as shown in our SNAP trade.