Here's an example.
I traded King Digital Entertainment (KING) prior to earnings with the understanding that they had low expectations and that any beat would have killed my option contracts.
1. I know, as a Candy Crush player, that the game is fading in popularity. I've beat all the levels (yes, I have a problem), my friends don't play it as much and it's starting to get boring very fast. I don't know anyone that's ever paid for Candy Crush but obviously there are some degenerates out there (this is a good laugh https://www.youtube.com/watch?v=KYRcAKYYEG4). Bottom line is their number one game is dying and all their other games haven't gotten nearly the same traction as Candy Crush.
2. Who does this remind you of? Zynga Inc, which reported earnings the week prior to KING. After that earnings call they made a 52 week low. However, since then the shares have rallied, probably from a short squeeze as the overall market rallied. Their earning miss gave me even more confidence that King would miss.
3. KING is expanding through acquisitions. Once again who does this remind you of? Yes, Zynga. Remember when ZNGA paid $180 million for Draw Something? Everything went down hill from there. KING recently partnered with Non Stop Games (http://www.nonstop-games.com/2014/08/nonstop-games-joins-king). I have no idea who they are so I won't comment on how this will effect both companies business. But its worth noting that KING is having a difficult time growing organically.
1. From observing the last earnings there was going to be a ton of volatility to the up/downside. I thought a good probability if they missed that it would revisit the lows of the last earnings around 17.
2. Prior to earnings the stock looked technically weak below the 50 day moving average.
I am not an options guru by an means so I know I could have structured this trade differently possibly with a vertical spread to protect my downside risk or use a straddle but I wanted to keep it simple. I managed my risk through the size of my position.
What now....I think KING will likely fall to the low single digits with time. It will have its pops and drops but a few more earnings I think we'll be much lower. I currently still have my option position open but will close it if it gets above 14. I'm even considering rolling my contracts to November. KING announced a special dividend payable September 30th. Which is likely a ploy to keep investors from selling their share prior to the lock up period on September 22nd. Pretty convenient timing (http://www.businessinsider.com/king-digital-tanking-after-earnings-2014-8). When have you seen a fresh IPO pay out a dividend 6 months into an IPO? They're likely scared from what happened with Twitter (http://www.cnbc.com/id/101645678)
I have many of these ideas and sometimes I'm right and sometimes I'm wrong. The only thinking I know is how much I'll lose if I am wrong. My next idea will be Tiffany & Co. (TIF)
Here was my trade