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Microsoft Pre-earnings Momentum Trade

Microsoft has earnings due out on October 26th, 2017, after the market close, according to Wall Street Horizon. 7-days before then would be October 19th, 2017. Microsoft is the forgotten mega tech -- the third largest company in the world behind Apple and Alphabet, but it doesn't fall into any fun Acronyms, like FANG, or FAANG. 

But, this pre-earnings momentum back-test is unlike any other in that it is the only one, out of more than 4,000 scans, that has never lost over the last three-years. (This does not mean it deserves extra risk capital or that it is somehow infallible, but, we are sharing a fact.) Here we go. 

There is a bullish momentum pattern in Microsoft Corporation (NASDAQ:MSFT) stock 7 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market. The strategy won't work forever, but for now it is a momentum play that has not only returned 851.3%, but has also shown a win-rate of 100% over the last three-years. 

The logic behind the test is easy to understand -- in a bull market there can be a stock rise ahead of earnings on optimism, or upward momentum, that sets in the one-week before an earnings date. Now we can see it in Microsoft Corporation. 

The Bullish Option Trade Before Earnings in Microsoft Corporation 
We will examine the outcome of getting long a weekly call option in Microsoft Corporation 7-days before earnings (using calendar days) and selling the call before the earnings announcement. 

Here's the set-up in great clarity; again, note that the trade closes before earnings, so this trade does not make a bet on the earnings result. 


We can add another layer of risk management to the back-test by instituting and 40% stop loss and a 40% limit gain. Here is that setting: 


In English, at the close of each trading day we check to see if the long option is either up or down 40% relative to the open price. If it was, the trade was closed. 

We found this pattern by using the TradeMachine™ Pro scanner, searching for stocks that show bullish momentum 7-days before earnings. Here are the top results in the entire market over the last 3-years: 


Here are the results over the last three-years in Microsoft Corporation: 

MSFT: Long 40 Delta Call
% Wins: 100%
Wins: 12   Losses: 0
% Return:  851.3% 

Tap Here to See the Back-test

We see a 851.3% return, testing this over the last 12 earnings dates in Microsoft Corporation. That's a total of just 72 days (6-days for each earnings date, over 12 earnings dates). This has been the results of following the trend of bullish sentiment into earnings while avoiding the actual earnings result. 

This is not a magic bullet, even though it looks so good, there are no guarantees in the market. This is simply a bullish strategy. In the short-term it hasn't seen any losses, but more importantly, whether or not it loses on any given earnings run-up, the 851.3%  return in less than three-full months of trading is predicated on an idea of consistent momentum. 

The trade will lose sometimes, but over the most recent trading history, this momentum and optimism options trade has won ahead of earnings.

Setting Expectations 
While this strategy had an overall return of 851.3%, the trade details keep us in bounds with expectations: 
      ➡ The average percent return per trade was 51.68% over each six-day period. 

Back-testing More Time Periods in Microsoft Corporation 
Now we can look at just the last year as well: 

MSFT: Long 40 Delta Call
% Wins: 100%
Wins: 4   Losses: 0
% Return:  230.1% 

Tap Here to See the Back-test

We're now looking at 230.1% returns, on 4 winning trades and 0 losing trades. It's worth noting again that we are only talking about one-week of trading for each earnings release, so this is 230.1% in just 4-weeks of total trading. 
      ➡ The average percent return over the last year per trade was 53.93% over six-days, remarkably similar to the 51.68% average return over the last three-years. 

Bull markets tend to create optimism, whether it's deserved or not. To see how to test this for any stock 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.

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Thanks, Paul.  Some good info there - not all entirely new to me, but a good! refresher and it clears up the "long 40 delta" (which was what I was guessing it meant).

 Am I to infer then that the exp & strike are any that would give me 40 delta?  For example, MSFT right now has 10/20@75 and 11/3@75.5 (plus others) both around 40 delta.  Is any one preferred over the other, and if so why?

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10 minutes ago, skydragon said:

Thanks, Paul.  Some good info there - not all entirely new to me, but a good! refresher and it clears up the "long 40 delta" (which was what I was guessing it meant).

 Am I to infer then that the exp & strike are any that would give me 40 delta?  For example, MSFT right now has 10/20@75 and 11/3@75.5 (plus others) both around 40 delta.  Is any one preferred over the other, and if so why?

This article is referring to buying the ~40 delta call closest to, but not less than, 7 days to expiration. The article doesn't actually say, but you can click the Back-Test link and figure it out.

Edited by greenspan76

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Thanks, greenspan76.  I'm having trouble loading what I think would be the full backtest page.  I'm not a CMLviz client and I'm going through a proxy server at the moment.  But I think I have what I need for when the 19th rolls around, so I'm good.

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They normally test with 1 lots, so it would be the 'closest' call to 40 delta at the end of the trading day.  You could obviously do as you are suggesting to get it closer for your entire position, but that's what the backtester is doing.

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I'm still a bit of an options novice, but I have a couple observations/questions on this trade.  I invite expert critique.

This is a bullish momentum play (as is well stated).  Thus IMO many bullish trade strategies might be appropriate here.  In other words, the long 40 delta call is just one of many ways to profit.  I do like it, so don't get me wrong, but I am wondering if anyone has reviewed other strategies - for instance varying the delta, or testing another trade type (eg, bull put spread) - to squeeze more gains out of the opportunity (while still keeping risk/reward at a prudent level)?  This sort of analysis is beyond my skill level and time availability.  [This may be a rhetorical question, since the article doesn't actually stress the exclusion of other trade types.]

Secondly (and more importantly), I question the proposed expiration.  Since we are going long, theta is working against us and it accelerates as expiration approaches.  Might a couple months worth of time till exp be a better choice?  I realize that delta and gamma also kick into high gear as exp approaches, and that those factors (and lV as well) could considered such that they best work in our it becomes a balancing act. Again, it's a bit beyond my grasp to test this.  Also I'm beginning to wonder if I'm just overly 'sweating the small stuff'.

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1. I tried to play with deltas, 40 provides the best results, but other deltas work as well.

2. We want the maximum gamma. Yes, it comes on expense of theta working against us, but IV should keep the theta losses to minimum (similar to our earnings straddles).

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I got in at .95 yesterday, just got out at 1.37. 44% before commissions. It didn't take long to fill at 1.37. I suspect there is more room to run, but hit my target exit, so I exited. Interesting trade....

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