Managing gap-down risks during earnings season for stocks

Discussion in 'Risk Management' started by helpme_please, Aug 11, 2019.

  1. This thread is relevant for those who trade stocks.

    I had painful experience with huge gap-downs when a company announces their earnings and the earnings results disappointed the markets. Even when the earnings looked wonderful to me, the stock can sometimes still drop in double-digit percentage. Stops are useless against gap-downs of such magnitudes. The gap-down magnitude is particularly huge for U.S stocks due to Regulation FD (Fair disclosure).

    This is the dilemma I have. If I sell every stock in my portfolio before earnings are announced, I will never get wonderful gains because wonderful gains are reaped when a trader holds his position long enough. Furthermore, the stock can also experience huge gap-up on earnings outperformance. If I don't sell stock before earnings, stops don't work and I cannot think of any other risk management measure against the gap-down risk.

    This is certainly an issue worthy of risk management. Can the elitetraders here advise how they manage this painful risk? Thank you very much.
    Last edited: Aug 11, 2019
  2. TommyR


    would a high volume or liquid gap in after hours trading be of interest to a high net worth or long term investor? longer term return of an asset correctly annualised over decades is how to accrue large gains.
  3. It shouldn't matter to high networth or long-term investor but most people are not high networth and many traders' style is not long-term. For me, long-term means holding the position for multiple years. For me, I prefer to hold for weeks, months to at most 1 year.
  4. TommyR


    i would say clearly hft is not going on at night i think we can all at least agree on that so after hours would suggest high net worths.
  5. Amahrix


    You will never get the returns of the market without tail risk hedging, which sacrifices alpha but it sacrifices alpha you would’ve never gotten anyways, over the long run.

    This is a must watch, especially for you.

    The concept can get very deep but I can point you the direction for further research by yourself
  6. Bum


    I held a 6 figure stock portfolio for quite some time but got frustrated with the drops in a small # of stocks so I closed most stock positions & converted everything to call spreads. Do the math and the returns are so much better with less risk. You'll be able to put 60-75% of your $$ back in the bank as call spreads require much less capital. Profits are limited but most times you'll be happy if you get called away @ the upper strike. I was trading mostly large and mid cap stocks with good liquidity in the options.
  7. R1234


    That is a strategy I have been meaning to backtest and implement in my own trading if it looks good.

    What was your holding period for these credit spread trades? And how far out of the money were your 2 strikes?
  8. Bum


    I would usually go out around 6 months with the spreads so I didn't have to babysit them so often. I usually bought 1 ITM call and sold 1 OTM position just far enough out to pay for the premium of the ITM call. That gave me nearly the equivalent of owning the stock but with so much less capital required, the ROI was soooo much better. Risk was capped and happy with the return if got called away.
    R1234 likes this.
  9. tomorton


    This is a great question which addresses a real problem in shareholding. But shouldn't there be as many gap ups as gap downs? Since gap ups have no maximum value whereas gap downs can only go to zero, in a large enough sample run the gains should outweigh the losses.

    As long as a huge gap down doesn't wipe you out.

    And if that's the risk, then you need to be able to hedge. If you can't do that, then follow the conventional rule and get out before the earnings announcement.
    helpme_please likes this.
  10. qlai


    Obviously, no magic bullet here as you want to participate in the upside but not the downside.
    The rules I had when swing trading :
    1. Had to be up at least 10% on the name to hold through earnings.
    2. Bull markets are more forgiving, so earnings over-reactions are often bought or at least manipulated back to close the gap(for stocks with institutional participation).
    3. Accumulated overall profits allow for larger risk taking (so rule#1 can be adjusted).
    4. Convert some profits to puts (have not actually done it)
    #10     Aug 12, 2019
    Metamega, tomorton and helpme_please like this.