Many swing traders will close a position before the stock’s quarterly earnings release in order to avoid getting caught on the wrong side of a gap. My personal preference is to hold a position into earnings as more often than not, whatever “surprises” are built into the earnings release and forward guidance are already reflected in the charts. Of course more often than not is far from always so my preference to hold a position might not (and should not) be the preference for a more risk-adverse trader.

Also keep in mind that at times I do close positions ahead of a scheduled earnings release. For example, let’s say I’ve been in a trade for a couple of months with the trade close to approaching my final or preferred target. I might decide to book profits before earnings as the R/R (risk-to-reward ratio) is no longer favorable for holding out for a few more percentage points in profits while risking giving back much more, should the stock be negatively impacted by the earnings announcement or forward guidance.

Again, each trader must decide whether or not to hold into earnings. It is important to be aware that stop-loss orders DO NOT limit one’s downside risk to the amount of the stop-loss order with the big risk being large opening gaps that bypass the order. Stop-loss orders are essentially converted to markets orders once the stop-price has been hit OR exceeded. The potential exists for a large number of stop-loss orders to get filled at the open when a stock experiences a large gap. This ‘surge’ of orders further exacerbates the order imbalances (buyers vs. sellers) already caused by the news or earnings induced gap, hence the reason that many stocks peak out in the first 30 minutes (if not a few minutes after the open) on large gap days.

An alternative for longer-term swing or trend traders or those who decide to hold a position into earnings would be to purchase an OTM (out-of-the-money) put option on a long trade (or a call option a short trade) in lieu of a stop-loss order. For example, say that you were long 100 shares of XYZ trading at $50 per share and they were scheduled to report earnings tomorrow. You could buy 1 near-month put contract with a strike price of $47, thereby effectively limiting your downside risk to 6%, less the premium on the option and commission to purchase the put. Of course if your trade gaps higher and goes on to hit your target, your put will expire worthless (or you sell it for a loss after the earnings release).

Another benefit of protecting your downside on a trade with options vs. stop-loss order would be the rare but dreaded risk of getting caught in a flash-crash (they occasionally happen on individual stocks, not just the broad market). Again, a very rare occurrence but one in which your stop-loss order is likely to get filled at or even well below the stop price, only to see the stock rebound very sharply after the flash-crash and potentially leaving you with a much larger than expected loss. With a put (or call option for a short trade) in place, you’d not only be protected dollar for dollar on the downside (past your strike price) but you could benefit from a big surge in the volatility premium during a flash-crash.