MorningWord 7/26/16: One stock goes one way and the other goes the other. And this guy’s saying “Whaddya Want From Me?

by Dan July 26, 2016 9:43 am • Commentary

As a part time financial markets pundit and an active market participant I spend a lot of time analyzing stocks and markets in the public eye. While uncertainty is the norm when it comes to investing/trading, one thing you can take to the bank is that publicly listed companies will report quarterly earnings results and offer commentary about the current business environment. It happens every 3 months.  Because we know that as a certainty, investors and the financial media spending a lot of time handicapping results and guidance.

Which brings me to a tweet I got during last night’s Fast Money program on CNBC:

It’s a good question. But it has a simple answer. If your time horizon is that short, and you’re just considering a directional view for a trade on the event, the odds are really stacked against you.

We spend a lot of time discussing implied earnings moves in the options market. Here is what I wrote for Apple (AAPL) this morning, results due after the close:

Event: Apple (AAPL) reports their fiscal Q3 results tonight after the close. The options market is implying about a 4% move in either direction*, which is shy to the average of about 5.5% over the last 4 quarters, and shy to the 10 year average of about 4.8%.  AAPL has declined the day following 4 of the last 5 results and on average 6.35% over the last two quarterly reports.

*With the stock at $97.45, the July 29th weekly 97.50 straddle (the call premium + the put premium) is offered at $4, if you bought that (which is almost all essentially the implied earnings move) you would need a move above $101.50 or below $93.50 by Friday’s close to break-even.

For the most part AAPL’s daily implied movement is less than 1%, but into tonight’s print the options market is implying more than 4x that.  We analyze various inputs that go into a company’s quarterly results and forward guidance, but it’s all just guess work until they report. And even then there are situations where results are not exactly as they appear (tax rates, buybacks, charges, channel stuffing etc etc) and/or the commentary is disingenuous, overly optimistic or overly pessimistic for various reasons specific to the company.

So I’ll offer our normal disclaimer for long premium directional options trades, as I think very applicable to taking a short term view into an earnings event: you need to get a lot of things right to just break-even, direction, timing and magnitude of the move. While this makes most sense when trading options around events it is also important to consider for those who subscribe to the trading rule of not letting trades turn into investments.

And speaking of investments, earnings events can provide great opportunities to use options to overlay against existing positioning for investors who do not intend to alter their positioning into the potentially volatile event. That’s where options help. That’s smart investing. For instance, an increase in options premiums 4x a year into a company’s earnings provides a great opportunity to add yield enhancement strategies against existing longs when options prices are high, or the opportunity to better define ones risk into the event, knowing the perceived risk in the options market abates after the event.

So when I spend time detailing scenarios about what is going to happen out of a company’s earnings call, remember, no one knows. The handicapping process helps me better understand such things as sentiment, and how investors are positioned. And ultimately that information is most helpful for investing and trading as a whole, not necessarily guessing which way a stock is going to go on a largely binary and unknown event.