Next Week: An Earnings Strategy

Setting the Table for FWLT and WFMI

Dear Bottarelli Research Member,

As we close out the trading week, let’s take a moment to reflect on what we’ve encountered with our earnings-based plays. In the case of Amazon.com (AMZN – NASDAQ) we played calls in anticipation of good numbers, and we knocked the ball out of the ballpark. In the case of Agnico-Eagle Mines (AEM – NYSE), we timed the set-up perfectly, playing calls in anticipation of a gold pop, a U.S. dollar dip, and strong earnings. As it turned out, two of these three items occurred, but since AEM stunk up the joint with their earnings report, the stock moved lower.

All things considered, the gains from Amazon heavily outweighed the losses from AEM. But nevertheless, it goes to show you that playing earnings moves in only one direction is always a coin flip, no matter how perfectly you time the position.

Therefore, going into next week, I’d like to offer an alternative earnings strategy that involves playing a hedge position. That way, you can still participate in a powerful upside (or downside) earnings reaction and yet still be covered if your position moves opposite of what you think. When it comes to playing earnings, it’s the very best way to have your cake and eat it too.

Here’s the scoop…

Next Wednesday, we’ll get earnings reports from two companies. Engineering giant Foster Wheeler (FWLT – NASDAQ) reports before the bell, and they’re expected to earn $0.63 per share.

Organic grocery store leader Whole Foods Market (WFMI – NASDAQ) reports after the close, and they’re expected to earn $0.18 per share.

In my opinion, the increase in oil prices combined with expectations of a forthcoming economic recovery, will spark an upside move in FWLT. On the flipside, since WFMI has been rallying so much recently, I think that their earnings report will give way to a classic “sell on news” scenario. As a result, my trading thesis is to play FWLT to the upside and WFMI to the downside leading into Wednesday’s pre-market and after-market reports. Specifically, I’m looking at these two positions:

• Earnings Play #1: WFMI November 33 Puts (FWZ WG), currently trading between $1.75 and $1.80 per contract.
• Earnings Play #2: FWLT November 28 Calls (UFB KK), currently trading between $2.05 and $2.15 per contract.

Now, what if the exact opposite scenario occurs, and WFMI rallies while FWLT falls? After all, as you’ve seen with AMZN and AEM, earnings reports can certainly surprise you. Therefore, to protect against a possible counter-move, I’d like to combine the two positions above with protective hedges.

The idea is to add two protective plays that’ll move in the opposite direction of your forecasted bias. While not as expensive as your primary plays, these hedges are designed to protect your back-side just in case the directional moves you expect fail to materialize. In fact, in many cases, a violent earnings reaction (either up or down) could actually turn these hedge plays into winning positions. Therefore, if traded correctly, we can hit a winner even if our original bias is totally wrong. In terms of these hedge plays, I’m looking at these two positions:

• WFMI Earnings Hedge: WFMI November 36 Calls (FWZ KQ), currently trading between $0.56 and $0.58 per contract.
• FWLT Earnings Hedge: FWLT November 25 Puts (UFB WE), currently trading between $0.45 and $0.50 per contract.

All told, the combination of FWLT calls/puts would cost around $2.60 and the WFMI calls/puts would cost around $2.40. In my opinion, any strong earnings-based move on either company could easily allow us to sell each basket for levels above these entry points, thus locking in a nice profit.

As it stands today, there’s no sense adding this position now, simply because we’ll get exposed to a weekend of time decay. So, the very best tactical strategy is to enter these plays on Monday, and hold onto them leading into Wednesday’s earnings. Depending on how each stock reacts, we’ll then be able to tweak our strategy from that point on.

I wanted to alert you to this maneuver today, so that come Monday, we’ll all be ready to deploy these two earnings-based plays in preparation for some earnings action on Wednesday. So on that note, get prepared. Because next week, things could sure get exciting!

And as always…

Lock and load!

Sincerely,