Here’s to spotting hot stocks BEFORE Wall Street pours money into them!
Hey everyone, JD here with your Rational Trader Market Analysis Daily.
Today kicks off what I expect to be a fast and furious week of mean reversion cash machine trading.
We’ve got earnings season in full swing, implied volatility is elevated, and the opportunities to write rich options premiums are stacking up fast.
So on to today’s video…
Why Mean Reversion Works During Earnings Season
Both of today’s trade ideas are classic mean reversion setups — the kind of trade where prices temporarily stray far from their statistical average, only to get pulled back toward that mean once the hype dies down.
(Mean reversion, for those newer to the concept, is the idea that prices tend to revert back to a central tendency — like a rubber band snapping back after it’s stretched.)
In these setups, I’m looking to sell premium on both sides of the market — writing calls and puts far outside the expected range. The goal isn’t to guess direction. It’s to get paid as long as the stock doesn’t do anything crazy after earnings.
Let’s dig in.
Trade #1: Lockheed Martin (LMT)
First up is Lockheed Martin.
The stock is currently sitting well outside its typical volatility range. Based on my models, the mean is sitting somewhere around $464 the two-standard-deviation range extending from roughly $455 on the low end to $474 on the high end.
(Standard deviation, by the way, is a statistical measure that tells us how far a price is likely to move from its average. Two standard deviations in either direction covers about 95% of expected price movement — meaning anything beyond that is rare.)
What I’m doing here is selling a $515 call and a $420 put. Both of those strikes are well outside that two-standard-deviation range. In fact, $515 doesn’t even show up on the chart’s scale — that’s how far out it is.
And the premiums? They’re fat. Last I checked, you could write these options into the close for about $0.65 each — an excellent payout for taking on very little directional risk.
Historical Volatility Tells the Story
Let’s look at how Lockheed behaves after earnings.
In the past 5 years, Lockheed has reported earnings 20 times — finishing up 9 times and down 11 times. So it’s close to a coin flip, but with a slight bearish edge.
- Median positive return: +2.4%
- Median negative return: –3.3%
The biggest one-day post-earnings pop was 8.7% back in 2022.
So even in its most aggressive move, it wouldn’t break through my $515 strike, which is 10% above the current price. And remember, most of the time, it doesn’t come close to that size move.
That’s why I’m calling this a “ring the cash register” trade. The odds are stacked in your favor, the premiums are juicy, and the risk is very manageable.
Trade #2: Philip Morris (PM)
Now let’s talk about Philip Morris, which might be an even better setup.
PM is currently trading right at the mean (just above $180) heading into its earnings report, which is expected tomorrow morning before the market opens. The two-standard-deviations range goes from about $175 on the low end to about $184 on the high end.
That gives us a clean opportunity to bracket the trade with some serious breathing room. Here’s what I’m doing:
- Sell the $195 call
- Sell the $160 put
That’s an 8 to 12% buffer on either side. And just like Lockheed, the premiums are very attractive.
Outliers? Sure. But Look at the Medians
Now, I’ll be the first to admit: Philip Morris has had a couple of big moves in recent reports. Two out of the last three earnings announcements saw the stock jump just over 10%.
But those are outliers, and even when we include them in the data, the median numbers still tell a strong story:
- Median positive return: +3.2%
- Median negative return: –2.7%
In other words, the typical move is nowhere near what’s being priced in. That’s what makes this a classic mean reversion play. We’re selling against inflated expectations that rarely materialize.
And to be clear, the $195 call I’m selling is about 8% above the current price, and the $160 put is about 11% below. That’s more than enough room to handle normal earnings volatility, even if the market gets a little jumpy.
The Plan for the Week Ahead
These two setups — Lockheed Martin and Philip Morris — are textbook examples of what I’m looking to do all week.
We’ve got an ideal environment:
- Earnings season in full swing
- Implied volatility running hot
- Plenty of stocks drifting beyond their expected range
My plan is simple: keep writing calls and puts far outside two standard deviations, collect premium, and let mean reversion do the heavy lifting.
Good luck out there, and stay sharp. I’ll be back tomorrow to recap how these trades played out and to tee up two more.
Talk soon,
JD
The Rational Trader
I’ll be back Monday with more analysis.
Take care, everybody — and as always, stay rational.
Talk soon,
JD
The Rational Trader
