Audrey Deschenes
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Audrey Deschenes in Trading. Let's get it started!,

How to game Facebook and Microsoft earnings

I always call it “gambling” when I trade around earnings.

Trying to game earnings reports is one of the hardest and most volatile ways of trading. In fact, most technical analysts and many of the best traders I know abhor making a move when an earnings report is near. Long-term investors are best served by ignoring the often wild moves that a stock they own will make after an earnings report. That said, using a huge post-earnings selloff to scale into a stock you want to own for the long term is one of the best strategies for any investor’s playbook.

When you try to game an earnings report, you’ve got to get three things right:

1. What the fundamentals of the last 90 days have shaped up to and whether the reported result is going to be better or worse than expected.

2. Know what the sentiment around the stock and the expectation for that earnings report is. If everybody’s expecting blowout numbers that can set a bar that’s too high to catalyze an earnings report pop. Vice versa if everybody’s expecting disaster and a collapse. It’s a version of the buy-the-rumor, sell-the-news dynamic that’s often inherent in trading.

3. Figure out the best way to trade the reaction to earnings that you expect after the company reports. Sometimes you can buy some near-term call or put options to benefit from a huge post-earnings move. Sometimes the premium on those options are too high to mess with, so you’re better off trying to buy/short the common stock itself.

I’ll be applying these concepts to a few high-profile upcoming earnings reports during the earnings season. Our first featured earnings report analysis is for Microsoft and Facebook.

Microsoft:

1. Microsoft’s MSFT got a new cheif executive and lots of backlog of revenue to book. We know too that Intel INTC recently said PC sales have stabilized and there’s demand in the pipeline for more. That leads me to think the report itself will be “better-than-expected.”

2. The sentiment around the stock is mild, despite the stock’s being near 10-year highs. Despite Intel’s strong report last week, expectations are pretty mum for Softee into their report tonight.

3. Premiums on MSFT calls and the puts are rather cheap as the market doesn’t seem to expect any big move after Microsoft’s report tonight.

This all leads me to conclude that I’d rather be long than short Microsoft into tonight’s report. If I were in the mood for speculating and gambling, I might even look at the Microsoft November call options. I’d know that with any options trade, I could lose the whole nut that I bet on them with.

Facebook:

1. My analysis points to Facebook FB likely having monetized their user base much better than most analysts had modeled for the last few months. The video ads, app download ads and other means of generating revenue from users is catching a lot of traction very quickly. That leads me to think the report itself will be better than expected.

2. The sentiment around the stock is very positive and expectations have been ratcheted up over the most recent couple quarterly earnings blowout reports that FB delivered. Facebook’s got a high bar set for itself, but earnings could come in even better than most analysts expect.

3. Premiums on FB calls and the puts are probably too high to make them good risk/rewards.

This all leads me to conclude that FB’s reaction to its upcoming earnings report is way too hard to game and try to profit on. I’ll stick with my long-held Facebook common shares that I’ve owned since I was the only idiot on the planet buying Facebook.

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