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This series of articles is intended to show traders a way to profit during earnings season. In our mock trade, we chose to use ConocoPhillips (COP). This oil company has had a nice run, but we expected it to decline on its earnings announcement Wednesday. Implied volatility was high on the stock’s options and we expected some selling on the news. However, earnings were so strong Wednesday that the stock actually moved higher, but there are some signs that it will still move lower.

The strategy we chose to use was a bear call spread. We chose this strategy because it was short term and provided a nice reward-to-risk ratio. When we entered the trade, COP shares were trading at $60.57, which meant the stock was trading below our breakeven point. Thus, we needed just a sideways move or a drop in price to see a profit. Below is the data for this trade:

June 19, 2005
COP @ $60.57
Buy 5 Jul 62.50 calls @ 1.05
Sell 5 Jul 60 calls @ 2.05
Total Credit = $500
Max Risk = $750
Max Reward = $500
Breakeven = $61.00

June 27, 2005
COP @ $62.17
5 Aug 62.50 calls @ 1.40 (Sell)
5 Aug 60 calls @ 3.00 (Buy)
Total Credit = $500
Current Loss = $300
Max Risk = $750
Max Reward = $500
Breakeven = $61.00

One question I have received about this trade is my statement about a stock pricing in good news ahead of the actual event. Often, when a company is expected to announce very strong earnings, its stock will rise in advance of the actual announcement. However, on the actual news, the stock will decline. This is a common thing, especially when a company pre-announces strong earnings.

In the case of COP, earnings were extremely strong and this has led to further gains for the stock. However, the stock is seeing less volatility and it looks like some profit taking could take place. Right now, the stock is trading 33-cents below the max loss point. Of course, each trader has their own exit points and these should be followed. For example, you might have set an exit when the trade is down $500. However, we will follow this trade until expiration to show how a bear call spread works. Below is the current risk graph for the trade:

Figure 1: Risk Graph of COP Trade

Despite the stock’s gains Wednesday, it only needs to decline 3.6 percent to put us back in max profit territory. As mentioned earlier, managing a trade is critical, so stick with your exit points. Maybe they were too tight, maybe too loose, so learn from your trades, but stick with them to take the emotion out the trade. 

Please feel free to ask questions and make comments on my discussion board. We can all learn from each other. Let me know what alternatives to this strategy could have been used and what concerns you have with the trade. 

To read previous installments of Real-World Trading, please click here.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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