Saturday Review For Feb 5, 2022

Everyone loves earnings season, except maybe Mark Zuckerberg. To rephrase this, option traders love earnings season. The volume for individual stock options is multiples of that during a non-earnings week and the outlier results offer the business press a lot to talk about.

I focus on the Nasdaq-100 and several of the large NDX components reported over the past couple of week. The summary below includes the date that the stock reacts (not the announcement date), what the stock did the day after reporting, what was being priced in by the option market, and finally the average move higher or lower for the previous eight quarters. My definition of a positive report is if the stock moves up more than the average move and a negative report if the stock moves lower more than the average.  Falling in the historical range (MSFT is the only one this time around) is defined as neutral regardless of direction.

 

The results for these big NDX stocks was as mixed as I can recall with three companies experiencing outlier downside moves (FB, PYPL, and TSLA) and four stocks experiencing outlier upside moves (AAPL, AMZN, GOOG, and GOOGL). One thing I have found while analyzing expectations going into earnings is that when a stock has an outlier move, options will price in a larger move the following quarter. A characteristic I attribute to all of us having short memories.

Despite mixed earnings results, NDX was higher last week along with the other two broad based indices, rising 1.66%. Among the volatility indices, VOLQ dropped the least, losing 9.91%, possibly due to higher risk and uncertainty associated with the major components. Typically, VOLQ experiences a post earnings crush we associate with individual stocks options, a pattern that did not repeat on a relative basis as earnings season ended.

At least one trade believes NDX will continue to grind higher over the next few weeks. On Friday, with the underlying at 14627.63 a trader bought over 100 of the Mar 18^th 14550 Calls for 587.22 and sold the same number of Mar 18^th 14900 Calls for 389.22 and a net cost of 198.

The risk for this trade is a loss of 198 if NDX drops below the lower strike price while there is a potential return of 152 with a move over the higher strike price of 14900. The risk reward is not as favorable as I would like, but this is a good example of using options in lieu of a target price and stop order, something that makes a lot of sense in the current market environment.

Turing to the VIX arena, the week over week change for spot VIX and associated futures is a textbook example of a shift from backwardation to contango.

Farther out on the curve July finished at a slight discount to August. I did not pick up on that until the markets were closed for the week, but plan on looking at putting on a calendar spread shorting July and buying August based on the assumption that in time July should move to a discount over the next few months.

The VIX indices all moved lower as well with the 9-day version losing almost 6 points dropping from around 28 to 22. This also places short dated volatility expectations at a discount to VIX.

Finally, the small cap arena did well last week with the Russell 2000 gaining 1.72%. There has been a talking head theme regarding RUT with the expectation that higher inflation and interest rates. For the year, RUT is down 10.8%, not too far from NDX’s 9.9% drop in 2022. For the record, the S&P 500 is the best in class losing a bit more than 6% year to date.

I did not have to look too much to find a bullish RUT trade from last week as sentiment does seem to be turning positive for small cap stocks. Early Friday RUT was at 1983.38 when a trader sold the RUT Mar 18^th 2000 Puts for 83.68 and purchased the RUT Mar 18^th 1950 Put for 63.68 taking in a credit of 20.00.

Two final observations related to this bullish spread. First, it expires on the same day as the NDX trade discussed above, but was executed when the underlying market was quoted at a level where the trade makes (a little) money at expiration. Also specific to this trade, RUT finished Friday just over 2000, a critical level as it delineates a level where the trade will realize a maximum profit at expiration in March.