When Earnings Fall Stock Prices Are Next

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When Earnings Fall Stock
Prices Are Next

http://www.options-trading-education.com/24670/when-earnings-fall-stock-prices-are-next/
The best argument for why the stock
market rally continues in the face of
overpriced stocks is that earnings have
been strong.

But when the market is leveraged to
the hilt and earnings disappoint what
happens?

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Before We Continue…

The fact is that when earnings fall
stock prices are next.

Reuters writes that stocks fell when
bank earnings were weak.

U.S. stocks fell on Thursday morning,
dragged down by media companies,
while results from JPMorgan and
Citigroup failed to fuel the optimism
that has driven indexes to record
highs.

“After a long stretch of consecutive
highs in the market, with earnings,
even if they are slightly
disappointing, or an even an aspect
of earnings like bond trading at JPM,
is more an excuse to selloff,”

said Scott Clemons, chief investment
strategist for Brown Brothers
Harriman in New York.

The point is that there are big
investors who have been hanging on
for the last bit of gain before exiting
the market.

These folks are looking for an excuse
to get out.

But is there an alternative to selling
stocks when the market might still
have a ways to go?

Buying puts on stocks that you own
allows you to hold the stock in case of
an upside move and protect yourself
against a market correction or crash.

A put contract in options trading gives
the buyer the right to sell his stock at a
set price even if the market falls.

The buyer pays a premium for this
sort of insurance which lasts for the
duration of the options contract.

When the cost of a put option is not
too large this is a good route to go to
protect your gains in a rising stock.

When the market has decided that
your stock is too risky the price of the
put option will be prohibitive.

That is when it will be time for you to
sell before the crash.

Like the 1987 Crash

As earnings falter how will this market
rally end?

CNBC writes that the 1987 bust is a
guide.

They say that the market may still rise
a bit which they refer to as a melt up.

"A melt-up to a certain extent kind of
creates its own demise.

To the extent that this market
continues to move higher, maybe
starts to move higher at a faster pace

now that would indicate to me that a
lot of investors are coming in a little
late into this bull market, and doing it
with ETFs," Yardeni said Tuesday on
CNBC's "Futures Now."

"As in 1987, they could create a sort
of portfolio insurance effect where
suddenly something happens."

He's referring to the crash on Oct. 19,
1987, otherwise known as Black
Monday.

It's the day the Dow plummeted by 23
percent after early computers on
Wall Street spotted market weakness
and tried to protect financial
institutions by selling.

But they weren't sophisticated
enough to stop.

That time it took the market 15
months to recover its losses.

The same advice regarding buying
puts applies here as well.

When Earnings Fall Stock Prices Are Next

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