For many industry group moves, you can often find "cousin" stocks that go along for the ride. Many times they provide the infrastructure, supplies or services that help an industry get stronger. That's what put Toast on our radar as a cousin stock to the restaurant group. But how do you handle a stock you want to own when earnings are about to be announced? Here are two strategies to look at.
Why Cousin Stocks Are Worth Watching
There are countless examples of cousin stocks doing well for investors. Back in the 1960s, jet travel was a new innovation and it sparked many cousin stocks along with it. Hotels cropped up to support travelers. Suppliers to airlines, like Monogram Industries supplying Boeing with toilets for airlines, also had phenomenal moves.
The restaurant industry group is currently one of the strongest in the market, based on 6-month relative strength. Toast provides hardware and software solutions for restaurant management. When you pull out your credit card to pay, you might often find the name Toast where you tap your card.
Toast had its initial public offering in 2021 and quickly suffered an 80% correction in the 2022 bear market. It formed a large deep cup with handle in 2023 and the handle has formed a base in its own right. Plus the handle in Toast was much tighter with just a 16% depth.
Options Earnings Strategy For Toast
The problem was that while Toast had a nice setup, earnings were right around the corner. IBD's Leaderboard handled it by taking on an earnings option play. Buying the 24 strike call option with a May 17 expiration cost around 1.90 the day before earnings (1). It was little high on the risk side, so we used a half position to minimize damage to the portfolio in case it didn't work. With options near expiration, it often either works or it doesn't. So you have to expect you could lose the whole amount.
For a $100,000 portfolio using a full position at 10%, a half position would come in around two contracts. Each contract controls 100 shares, so exercising the call option and taking the shares would have a cost just over $5,000 and a risk of $380 (premium multiplied by two contracts). It translates to less than 0.5% risk to the portfolio if the option expires worthless.
This strategy is outlined in our weekly Earnings Preview column.
A Strategy For Earnings Gaps
For SwingTrader, we took a different approach. Toast gapped up about 6% on the open after its earnings report. It got as low as 24.83 in the first five minutes (2) but within a couple of hours (3), it was all the way up to 27.31.
Studying market behavior, you'll notice that many times with big moves, either up or down, there will be an opposite reaction that backtracks around 50%. For SwingTrader, we wanted to establish a position but as Toast kept running higher, it made using the low of the day as a stop an uncomfortably large risk: up to 9% at the high.
We looked at a 50% retracement (4) around 26.07 as a potential chance for an entry. That would put the risk at a more palatable 4.8%. Going with a half position would minimize the risk even more.
Toast started bouncing (5) just before getting to the 50% retracement level and we put it on SwingTrader at 26.36. If Toast continued below the 50% retracement and stayed there, we would have skipped the trade. Even spending too much time below that level after our entry would make it look less than ideal at this point. But using this strategy for the earnings gap gave us a good entry with a risk level we could handle.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
