Despite Friday’s sell off, most stocks that reported Q1 results last week saw positive price action. Most notable was the performance of a handful of so called bell-weathers that had a tough Q1, but posted gains on the week (a week that saw the S&P500 decline 1%.)
INTC rose nearly 2%, after a 4.25% one day gain post results, JPM was up 2% after a beat and generally solid commentary, PM was up almost 10% on the week. Oh and there was NFLX, up 25% on the week, with the stock now up 67% on the year! What’s interesting in all these cases is that expectations were low heading into the prints. INTC and PM had been in the penalty box given their exposure to the US dollar strength, while JPM was believed to be in a benign profit environment given continued regulatory pressure and low rates. As for NFLX, the low expectations were based on competition and valuation. All had reasons to try to poke holes in their respective stories, but in all cases the sentiment appeared to be worse than the current business reality.
As we head into what is certain to be a busier week on the earnings front (calendar here) with headliners IBM, CMG, YHOO, BA, CAT, AMZN, GOOG and MSFT. Regular readers know that we focus on a short list of inputs to determine whether or not we think expectations are high or low heading into a quarterly report. While this list is a combination of qualitative and quantitative, there are few more important than the implied move in the options market. We get a lot of questions on this, as readers often think it is a fairly complicated calculation, which is kind of was before the proliferation of weekly options.
For an example on how to calculate, let’s look at IBM, a stock that fits into the out of favor large multi-national with heavy exposure to the strong dollar, like INTC. The stock is clearly out of favor among tech investors, down 18% from its 52 week highs, but trying to find a bottom as the stock has based between $150 and $165 for the better part of the last 6 months.
With the stock around $160, the April 24th weekly (this Friday straddle, the call and the put of the same expiration) is offered at about $6.20. If you were to buy that, you would need a move by Friday’s close of at least $6.20 in either direction to break-even, either above $166.20 or below $153.80 (or about 3.7%.) Despite the company reporting earnings today after the close, and 5 trading days to weekly expiration, it is safe to assume that most of the extrinsic premium in the options will come out quickly following the results. The best way to estimate just how much is to look at the implied vol over time. Here’s IBM’s 2 year 30 day implied volatility:
Right now May vol is about 24. As you can see in this chart it will likely be about 15 after earnings. That’s significant as about 35% of the extrinsic value will come out of May options just on declining vol once the news is known.
We will take a more in-depth look at IBM prior to the result, but in your own trading, we think it makes sense to get a sense for what market makers are expecting in and around stock’s earnings reports, as they are one of four days of the year that traders expect greater than expected movement.