subject: Beware of The Volatility Headfake: One Good Downward Spike [print this page] Beware of The Volatility Headfake: One Good Downward Spike
When I read declarations by Goldman about the median daily movesfor stocks duringearnings season the hair on the back of my neck stands up, it reminds me of the old trading days where whatever you see or hear is not real and you better strap on your counter intuitive hat so you don't get on the wrong bus.
It's also very scary when Goldman starts broadcasting trading strategy (this clearly can only be a head fake)regarding selling MSFT covered calls for clients. Shorting Call Option premiumduring a hard selloff while you are long the under lying stock is a losing trade, and one Goldman would gladly take the other side of.
This tells me thatmarkets are about to take a huge dump after a long rally. There is absolutely zero chance that Goldman Traders would let anyone know what they intend to do for their largest clients. I shouldexplain that Prop Trading is gone from the desks on Wall Street but there is not a trader in his right mind that would let an internal strategy go out to the wires. Below is some information from a variety of news services talking about this subject and it made me laugh!! Beware !! We are due for Volatility and a good downward spike.
The current earnings season so far has been one of the least volatile in years with large, one-day moves in shares after a company reports results a rare occurrence, Goldman Sachs Group strategists said. On average, stocks have moved 2.7 percent on their earnings reporting days, the lowest average daily move for the first two weeks of earnings since 2007, wrote equity derivative strategists John Marshall and Maria Grant in a report on Wednesday.
The four-year median daily move is 4.8 percent. "If earnings moves continue to be so modest, this could be the least volatile earnings season since our data series begins in 2003," the strategists wrote. They are now leaning toward more option selling strategies given the stable earnings results and small moves in the shares.
With a strong start to earnings season, high expectations have been priced into shares, and only very large earnings surprises have been rewarded with big moves.
So far, only 17 percent of stocks have moved more than the options market implied on earnings day, making volatility buying strategies challenging, the analysts said. Goldman lists only 12 stocks that have made earnings day moves 25 percent greater than their median move over the past eight quarters, a list that includes Google Inc (Nasdaq:GOOG ), Alcoa (NYSE:AA ) and Halliburton (NYSE:HAL).
Given this pattern, along with a recent trend of late reporting results being less volatile in general, the options team sees opportunities to sell options or employ more volatility-neutral strategies to capture more modest moves.
For example, the team recommended that Microsoft Corp's (NasdaqGS:MSFT ) stockholders should consider selling January 2011 $27.50 covered calls to increase yield on what has been a range-bound stock. Microsoft earnings, due on Thursday, are unlikely to be a meaningful catalyst, they said. Covered calls involve selling a call option to gain income on a long position in the shares. Investors selling covered calls risk limiting the stock upside to the call strike and remain exposed to stock downside risk. An equity call option grants the right to buy shares at a fixed price any time until expiration.
Goldman pointed out stocks beating consensus earnings estimates by three standard deviations have had a median outperformance of 211 basis points vs the S&P 500, while firms beating by between one and three standard deviations have underperformed by a median of 17 basis points as of October 21.
