MorningWord 11/28/16: Mind the Gap

by Dan November 28, 2016 10:24 am • FREE ACCESS

We spend a lot of time discussing corporate quarterly earnings as they represent the potential for unusual volatility around a known event. For a stock market that spends most of its time trading on general macro themes on a day to day basis, this single stock volatility can be enticing.  The name of the game with earnings trading, especially when using options is gauging expectations and sentiment vs what will be reported (and foretasted). For the most part this is all guesswork, which is why we usually offer a disclaimer for traders looking to use options to express a directional view into an earnings print: you need to get a lot of things right to just break-even, first and foremost direction, and the magnitude of the move.  Which is why we often like to consider all of the above and wait until after earnings to make a more informed move.

Here are a couple great examples. In the last month (here & here) we have written skeptically about Salesforce.com (CRM).  The stock had under-performed many of its enterprise software peers and the broad market year to date, and was down on the year, and down 11% from its 2016 highs when they reported their Q3 results on Nov 16th. The stock gapped 3.5% higher the next day to levels not seen since late August the day prior to their Q2 print.  Since the gap, the stock has declined on 5 consecutive trading days, filling in the earnings gap and then some:

CRM ytd chart from Bloomberg
CRM ytd chart from Bloomberg

If one was negatively disposed prior to earnings, sat on their hands for the print displaying some discipline, then they got a great short entry.

On the flip side, we have had some skeptical commentary (here & here) on Walmart (WMT), a stock which has outperformed the broad market and many peers year to date. On Nov 17th following its Q3 results the stock declined 3% on disappointing results.  The stock has since spent the last week filling in its earnings gap:

WMT ytd from Bloomberg
WMT ytd from Bloomberg

Both are examples where the contrary position one out following earnings, but have since reverted back to the prior trend.  This is all hindsight obliviously, but the point here is that while the earnings dates are known, the outcomes are just as random as the stock’s potential movement on the days prior or the days following, just the expected volatility, in either direction is elevated. For those looking to make directional bets around earnings, it often pays to wait.