If you've been reading this column for any length of time, you could probably find plenty of examples of sells right before earnings. Often the risk of a gap down, and what that can do to a swing trading portfolio, isn't worth the risk. Yet, we held our position in Cava stock this time around. Here's why.
Cava Stock Sets Up
First, going into the most recent trade, we did have some experiences with Cava — though not profitable ones. Back in June we added Cava stock to SwingTrader (1) only to sell it a week later (2). The small loss looked great compared to the 27% correction Cava saw over the next month (3). But its upside reversal coincided with an upside reversal in the major stock market indexes.
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As Cava lifted above its 50-day moving average line (4), we took the opportunity to add it back to SwingTrader. There were good and bad parts to the entry. On the good side, it gave us a lower cost entry at 88.73. But since it was a few days before the Aug. 13 follow-through day, it was hard to know if we were too early. Plus, we knew that our time was limited to make the trade work ahead of its upcoming earnings report after the close on Aug. 22.
That combination led us to scale back the position the next day (5). Knocking it down to just a quarter position gave us a lot more flexibility with how we handled it. The smaller position meant we had less risk. Of course that comes with an opportunity cost. If the stock does well, you don't make as much money with a smaller position.
A Shift In Handling Earnings
As Cava inched higher almost daily, it was an easy hold. The day before its earnings report was due, we had a 16% gain on the position. (6) In looking at the options market, we had the market expectation for Cava to stay within a 10% trading range after earnings. We calculated that by taking the at-the-money call and put options for the nearest term and adding them together. That tells us an expected range for the earnings move but not the direction.
For most of the year, many of our sells ahead of earnings knocked us out of good positions. Given our early entry, the cushion of gains, the reduced position size and the early start of the rally, we decided to hold through earnings.
Giving up a potential 10% off a 16% cushion was worth the risk. Because of the reduced position, the math works out that it would only be a little more than a quarter of a percent risk to the portfolio if Cava fell 10%. Sure, it could fall more but we were going with the odds, a calculated risk.
It paid off. Cava stock launched over 20% after beating earnings estimates and raising its outlook. (7) Now we have nearly a 40% gain from our entry. If Cava stock can consolidate the gains here, we may be able to add to the position down the road. That kind of cushion gives you a lot of flexibility.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Justin Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
