…we'll often see a smattering of "Sells" that typically reflect a fairly strong degree of negative sentiment toward a stock.

On the other hand, a heavy weighting of "Buys" means that optimism is at a peak and that there is much more room for downgrades than upgrades. In other words, the ratings are as optimistic as they are likely to ever be.

Although a lot of weight is placed on analysts' expectations, it's always a good idea to do a reality check when it comes to your own expectations for a stock's performance, particularly when you're getting ready to place your money on the table in front of an earnings announcement that could make or break your trade.

Decoding Investor Sentiment

It may seem counterintuitive, but a stock with relatively low expectations during earnings season stands a good chance of rallying, as there is plenty of sideline cash available to boost the price.

Conversely, high expectations can put downward pressure on a stock, as there is little to no sideline cash to drive the price higher. In fact, the path of least resistance for cash is to flow out of the stock, resulting in declining prices.

Your ultimate success when it comes to trading earnings for profits comes down to reading the people doing the buying and selling. And it's their desires, or sentiment, that dictates their behavior that determines whether to buy or sell (or, in our case, whether to buy calls or puts).

The most-accurate sentiment indicators generally reflect what investors are actually doing (i.e., what they're buying or selling) rather than what they're feeling and saying (i.e., poll results).

Using Options as an Earnings Indicator

Using option data is an excellent way to measure sentiment. Option volume and open interest (i.e., the number of open contracts on an option at the end of each day) data in the form of a stock's put/call ratio is one of the better ways to quantify investor sentiment.

High expectations (i.e., low put/call ratio, along with low short interest and a high percentage of analyst "Buy" recommendations) usually require a company to blow out earnings in order for the stock to rally. (See also: "Profitable Options Trading Strategies.")

Such stocks are vulnerable to disappointments if the company simply meets estimates or issues a tepid outlook for next quarter.

On the other hand…