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Old Saying Tells Us To Buy the Rumor, Sell the News?

Old Saying Tells Us To Buy the Rumor, Sell the News?

Old sayings often hold a kernel of truth on Wall Street. One of the oldest sayings in finance is to buy the rumor and sell the news indicating that by the time the news is announced the stock price already reflects any potential gains from whatever event was anticipated.

A 2014 paper validated this idea, noting,

“Consistent with the theory, institutions, who likely possess a short-lived informational advantage, “buy the rumor and sell the news,” buying before analyst upgrades and then selling when upgrades are announced.

Placebo tests confirm that these trading patterns are unique to instances where institutional investors have a short-lived informational advantage. In contrast, individuals, who are unlikely to be informed early, do not buy before or sell on upgrade announcements.

The results are largely supportive of the theoretical predictions and provide the first empirical evidence of the “sell the news” behavior.”

Now, traders have an opportunity to put this adage into action. As Barron’s noted,

“Just a few months ago, it was impossible for Impossible Burger’s parent company to compete with Beyond Meat in one key venue: grocery stores.

While Impossible Foods’ plant-based offerings were hits at chains like Restaurant Brands International’s (NYSE: QSR) Burger King and White Castle, the privately held Silicon Valley company could not sell its meatless products in supermarkets until it scored approval from the Food and Drug Administration for a key ingredient—heme. This meant that the company was potentially missing out on a market worth about $100 million a year.

Impossible Foods is now finally getting a chance to play, if you will, ketchup. The company last week emphasized that its Impossible Burger became the top-selling item at some grocery stores soon after its debut.

Supermarkets represent a growing distribution channel for Impossible Foods and its competitors, said MKM Partners analyst Brett Levy, in a recent note.

“Distribution availability is inching up,” Levy said. “Beyond has been a more active player in the at-home channel, including the availability in the likes of major chains like Safeway and Kroger [KR] but recent weeks have seen Impossible Foods products make their ways onto the shelves of a few west and east coast chains.”

Sales at grocery stores appear to represent a market worth at least $100 million a year, given that Beyond Meat alone has reported $54 million in retail revenue in this year’s first half.”

(Nasdaq: BYND) is near support and a break could send the stock much lower.

BYND daily chart

The weekly charts show the bubble like behavior in the stock.

BYND weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in BYND

For BYND, we could sell a November 15 $130 call for about $7.31 and buy a November 15 $135 call for about $5.80. This trade generates a credit of $1.51, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $151. The credit received when the trade is opened, $151 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $349. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($151).

This trade in BYND offers a potential return of about 43% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if BYND is below $130 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $349 for this trade in BYND.