How to Trade Applied Optoelectronics (AAOI) After an Earnings Rip

Discussion in 'Options' started by CML_Ophir, Aug 8, 2018.

  1. CML_Ophir

    CML_Ophir Sponsor

    How to Trade Applied Optoelectronics (AAOI) After an Earnings Rip


    The results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.

    There is a bullish momentum pattern in Applied Optoelectronics Inc (NASDAQ:AAOI) stock 2 calendar days after earnings, if and only if the stock showed a large gap up after the actual earnings announcement.

    This is a conditional entry -- the company reports earnings and if the stock move off of that report is a 3% gain or larger, then a bullish position is back-tested looking for continuing momentum. The event is rare, but when it has occurred, the back-test results are noteworthy.

    AAOI has been a maddening stock to own for many tech investors -- it was once a rocketing tech darling, came crashing down 70% in short order, and has since recovered about 30%. Here is a 3-year chart:


    But a back-test proves out that the key to successful option trading in this company over the last 5-years has been short bursts of bullish risk exposure only after an earnings beats.

    Applied Optoelectronics Inc (NASDAQ:AAOI) Earnings
    In Applied Optoelectronics Inc, if the stock move immediately following an earnings result was large (3% or more to the upside), if we test waiting two-days after that earnings announcement and then bought a three-week out of the money (40 delta) call, the results were quite strong.

    This back-test opens one-day after earnings were announced to try to find a stock that continues an upward trajectory after an earnings rally.

    Simply owning options after earnings, blindly, is likely not a good trade, but hand-picking the times and the stocks to do it in can be useful. We can test this approach without bias with a custom option back-test. Here is the timing set-up around earnings:


    * Condition: Wait for the one-day stock move off of earnings, and if it shows a 3% gain or more in the underlying, then, follow these rules:
    * Open the long out-of-the-money (40 delta) call two days after earnings.
    * Close the long call 14 calendar days after earnings.
    * Use the options closest to 21 days from expiration (but more than 14 days).

    This is a straight down the middle direction trade -- this trade wins if the stock is continues on an upward trajectory after a large earnings move the two-weeks following earnings and it will stand to lose if the stock does not rise. This is not a silver bullet -- it's a trade that needs to be carefully examined.

    But, this is a conditional back-test, which is to say, it only triggers if an event before it occurs.

    Since blindly owning calls can be a quick way to lose in the option market, we will apply a tight risk control to this analysis as well. We will add a 40% stop loss and a 40% limit gain.


    In English, at the close of every trading day, if the call is up 40% from the price at the start of the trade, it gets sold for a profit. If it is down 40%, it gets sold for a loss. This also has the benefit of taking profits if there is a stock rally early in the two-week period rather than waiting to close 14-days later.

    Another risk reducing move we made was to use 21-day options and only hold them for 14-days so the trade doesn't suffer from total premium decay.

    If we bought the 40 delta call in Applied Optoelectronics Inc (NASDAQ:AAOI) over the last five-years but only held it after earnings and after an earnings pop higher, we get these results:

    Long 40 Delta Call

    % Wins: 80%
    Wins: 8 Losses: 2
    % Return: 1644%

    Tap Here to See the Back-test
    The mechanics of the TradeMachine® are that it uses end of day prices for every back-test entry and exit (every trigger). AAOI likely doesn't have earnings due out until late July or early August, so setting an alert may be useful, which you can do below:

    Looking at Averages
    The overall return was 1644%; but the trade statistics tell us more with average trade results:
    ➡ The average return per trade was 65.8% over each 12-day period.
    ➡ The average return per winning trade was 93.4% over each 12-day period.
    ➡ The average return per losing trade was -44.5% over each 12-day period.

    We can do this same back-test and examine the results over the last two-years, the time period when the stock was wildly volatile:

    Long 40 Delta Call

    % Wins: 80%
    Wins: 4 Losses: 1
    % Return: 515%

    Tap Here to See the Back-test
    We see the same win-rate as we did over the five-year test (80%), and the average return per trade (including the loss) was 83.2%.

    Bullish momentum and sentiment can be quite powerful with the tailwind of an earnings beat. This is just one example of what has become a tradable phenomenon in AAOI. To identify patterns that repeat over and over again, empirically, we welcome you to watch this quick demonstration video:
    Tap Here to See the Tools at Work

    Risk Disclosure
    You should read the Characteristics and Risks of Standardized Options.

    Past performance is not an indication of future results.

    Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.

    Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.

    Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.
    Baron, tb123 and ajacobson like this.
  2. destriero



    This one stopped as well.
  3. CML_Ophir

    CML_Ophir Sponsor

    Actually it's doing quite well, not sure what you mean (see image below)
  4. destriero


    Was this bought on Aug 9 with shares opening at 42?

    Stop using "two days" and post the entry date.
  5. destriero


    Earnings AH on Aug7.

    Wait one trading day.

    Entry at the open on Aug9. Aug24 43.5C calls opened at $0.60 to $0.80.

    Aug24 43.5 calls traded at 0.02 at the open today, Aug10.

    I don't see how this wasn't stopped. Your entry would've taken place at the open on Aug9, but you don't post a date, you simply posted "two days." The shares opened at ~$42 on Aug 9. The Aug24 40D calls were the 43s or 43.5s. The stock dropped to $38.90 this morning which, ostensibly, would've have resulted in the trade being stopped-out.


    * Condition: Wait for the one-day stock move off of earnings, and if it shows a 3% gain or more in the underlying, then, follow these rules:
    * Open the long out-of-the-money (40 delta) call two days after earnings.
    * Close the long call 14 calendar days after earnings.
    * Use the options closest to 21 days from expiration (but more than 14 days).
    Last edited: Aug 10, 2018 at 6:55 PM
  6. August 8th stock closed at $40.92 1 day after earnings and was up more than 3%.

    The .40 delta using Aug31 expiration call was the $42.50 Call and it was listed at $1.25/$2.71 going into the end of hte day.

    So what fill did you theoretically get on such a wide b/a spread to be able to test this out? $1.98 was the mid-point but doubt you would get filled there. Also I believe I looked back and saw volume 3-4 contracts 3 days ago.

    Again, not knocking good research but this is not a realistic trade that can be done without huge assumptions on fill and being able to close.

    EDIT: I may be off a day on the entry but this stock has illiquid options and wide b/a spreads that I can see.
    CML_Ophir likes this.
  7. destriero


    Can't use Aug31 as it had more than 21 days to exp. The Aug24 had 16 days remaining. Regardless, both series would've been stopped out. The 42.50 was not 40D. Imagine a realistic fill on ANY of this stuff. You're stopped out on microstructure. Next trade and you're hosed lol.

    Ophir posts the net change as proof? Of what?

    He literally stated this can change your life. Yes, makes you poor.
  8. destriero


    Say you bought the bid on Thursday's open; $0.60. The thing was like 60x100 NBBO. You're looking at a 0.36 stop on the call. The NBBO was well under a dime at the open today. What do you do when your stop is gapped? Do you go to market? If so the thing would've been filled at 0.02 to 0.05.
    Last edited: Aug 10, 2018 at 7:34 PM
  9. Yeah I was researching this after market closed and using look back for option prices 2 days ago so not most reliable but the spreads were wide and if you buy at the ask or even inside the ask/mid point. You would need a huge move to overcome the spread to get out and you could be marked already down 40%. I think a filter needs to weed out illiquid spreads to add a little reality to this.
  10. destriero


    I am not trolling the guy. He stated the trade is doing well. Anyone trading this on Thursday morning would've paid close to a buck and been stopped this morning under a dime.