How do I trade Buybacks?
- ideal hold time: 1D (intraday)
- Suitable as a catalyst for longer term holds if the financials of the company are strong
- Bigger is better
- Watch out for earnings announcements and market selloffs confounding the trade
A company authorizes a stock buyback or repurchase agreement as a way of increasing the value of each share of stock. The company is removing shares of the company from the marketing, making remaining shares more valuable per share.
There are buybacks and there are buyback authorizations. A buyback is the transaction. A buyback authorization occurs when the company makes the decision to allocate capital towards future transactions/buybacks.
When the buyback is authorized, the price will typically move by at least the value of the buyback.
For example, if the company authorizes a $5 billion dollar buyback on a market cap of $50 billion, the share price will typically adjust to the anticipated buyback by +10%.
The market does not always price things efficiently right away. Sometimes the share price will rise quickly, other times it will rise more slowly over the day.
Buyback authorizations are announced outside of regular trading hours, because they are material to the share price. The company waits until the share price drops to a low point before repurchasing the stock.
There are several entry and exit points after a buyback authorization is announced. The stock usually rises immediately on the news, then pulls back after initial profit taking, Some traders buy right at 930am and sell within 20 minutes. Others stay in the stock over the long term if they believe in the company's future.
If the buyback happens in the morning, the stock price will usually end higher by the closing price, making this a great intraday trade. Often, peak price is seen at mid-day. So the ideal holding time for trading is to buy at the open and sell by the close.
If the stock buyback occurs in the evening ET, the share buyback will alter the price during the overnight hours because there is a lot of time between evening after the market closes at 4pm and 930am the next day - enough time for the buyback to get priced in. When this happens, there is usually a selloff at 930am the next day as traders and holders look to lock in gains. If the selling is strong, the share price will revert nearly to the closing price the previous day - this is the entry point for the trade.
A few caveats:
before buying the stock, check they actually have enough cash on hand to purchase the stock. Some companies announce buyback authorizations as a way to bolster the share price but don't have the cash to make it happen.
It's also good practice to ensure the company is in a sector that rewards buybacks - often growth stocks are punished for the decision as investors believe they mark an end to revenue growth.
If the market is selling off broadly, don't fight the trend. If the S&P 500 index is down more than -1%, it's going to be harder to make money. Generally, this is what throws off the win rates. Best to wait for a more positive day.
Check the earnings announcement day of the company. If the earnings report is bad or the CEO outlook is bad, that bad news will be weighed more heavily than the buyback and put a drag on the stock price. This is why our alerts have the earnings date on the alert.
Size matters. Larger buybacks as a percentage of market cap will move the share price more than smaller buybacks.
Misconceptions of "missing the trade"
There is a common misconception by traders that just because the price moves quickly afterhours you have “missed the move”.
We have addressed this topic in our weekly newsletters a few times. If you haven’t read them, we highly encourage you to do so as each week we comment on user questions.
The meat of it is:
1. Afterhours moves usually matter little because the change is based on the bid ask difference when volume is thin. The real price moves happen intraday.
2. If there is a large price move after hours there will typically be a reversal (selloff) at the open. The selloff creates an entry point. It also creates a chance to buy puts for a quick 30m trade. That’s two trades - one event. See the graph below of the SNX buyback and note there was very little volume driving price action in afterhours. A selloff followed. Staying with the trade instead of giving up on it would have yielded great returns.
3. It takes many hours for most market participants to learn of events. Sometimes the news writes about the same event for days. Few people can move as fast as Levelfields users. Reactions can occur over the length of the day. Look at Fiserv stock buyback from last week. The move happened after 1pm.
4. If you want to optimize your options plays, react to events that happen premarket not after 4pm as there is less time built in to allow traders to enter the trade.
5. If you really want to own a stock you can buy 100 shares afterhours and sell covered calls at the open. If the stock sells off you buy the calls back cheap for profit. You can do this multiple times in the same day. Or just once to lower the entry point of ownership.
6. Don’t trade on days where the market at large is tanking. It kills bullish trades
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