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How to Profit From 'Sell the News' Victims

Written By Trading Forex News on Wednesday, January 20, 2010 | 7:46 PM

"Sell the news" -- this is a quote we hear a lot during earnings season to describe the indescribable, a stock selling off after a benign-to-positive earnings report. Last week we saw this not-so-rare event happen for the second quarter in a row in the wake of Intel's (INTC) earnings report.

Last quarter, Intel posted better-than-expected results in a blowout earnings report, only to see its stock's price drop more than 6% during the next few trading days after the announcement. This quarter, the stock is posting a mirror image of its post-earnings price activity as INTC is trading almost 3% lower than its pre-earnings price of $21.55. Why?

To drive our point home we should give you a little more background. Our initial analysis had INTC on our bullish prospect list last week, and with the stock's fundamentals and technicals looking strong, we were prepared to buy a call on INTC ahead of its earnings report.

However, the dramatic run in the stock's price along with some signs that the bullish INTC trade had become crowded ahead of its report caused us to hold off on opening a call on the stock, a move that saved us from booking a losing trade.

We continue to educate investors on the power of the "expectational" trade during earnings season in order to help them identify these specific situations to avoid losses or create trading opportunities.

So, how do you avoid or take advantage of these situations?

First and foremost, identify them. Not surprisingly to us, the following headline flashed across our screens in the late-afternoon trading ahead of INTC's earnings report: "Expectations are high for the company's report as shares trade at highs heading into the close."

Like last quarter, INTC's price had rallied by more than 3% in the day leading up to their earnings report.

INTC Chart

Typically, these last-minute rallies are a sign that investors are pricing the stock for perfection ahead of the report. In other words, the market is raising the bar at the last minute, making a "beat" harder.

As a result, the stock is now set-up for a "sell the news" situation after the company's report whether the results are good or bad. Good results will typically take the stock back to its prices before the last-minute rally, bad numbers will see the stock get punished. As a general rule of thumb, the larger the magnitude of the pre-earnings rally, the larger the potential "sell the news" pullback.

In the latest case with Intel, we believe that the stock will continue to consolidate at the $21 level as earnings season moves forward. The stock will then likely provide an opportunity for the bulls to profit from a short run to the $22 level (a move of nearly 5%) during the next six weeks. A break below the $21 mark will see the stock pull back to $20 in short order before buyers start to step in to rally the stock back to the $21 level again.

For those looking to sell premiums, the $22 and $20 level should draw short- and intermediate-term highs and lows for INTC.

by Chris Johnson and Jon Lewis

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