Goldman Sachs recently forecast a return to stock-market volatility in January as companies preview their quarterly results or offer insight on what the year ahead might look like, and on Wednesday the investment bank recommended a way for play that volatility, a strategy it said a number of major technology companies were top candidates for.
“One of our favorite options strategies ahead of earnings is to buy straddles that cost the same as the typical one-day earnings move, but capture an extra week or two (sometimes more) of non-earnings days,” the investment bank wrote in a note to clients.
A straddle is an options strategy where an investor buys a bullish call option and a bearish put option at the same strike price. It is a bet that a stock will move by a certain amount, rather than in a particular direction. The cost of making such a bet depends on how big the investor expects the move to be, as well as how much time they are giving the stock to make the move. Goldman’s strategy focuses on stocks where the cost of holding the straddle for longer is equal to a stock with a shorter-term contract, but where the volatility could be just as pronounced.
“When applied strategically across a portfolio, this overlay can provide a hedge or amplify upside exposure should the market make a correlated up or down move,” wrote Katherine Fogertey, an options analyst. “Since 1996, buying the closest listed at the money straddle when it costs less than the earnings move 5 days ahead of earnings and closing the day after has produced an average return on premium of 24% (with a 56% hit rate) vs. 2% / 36% for all stocks ahead of earnings.”
A call option gives the holder the right but not the obligation to buy the underlying security at a set price by a certain time. A put option gives the holder the right but not the obligation to sell at a set price by a certain time.
The investment bank listed 20 stocks that it said this strategy applied to, including technology bellwethers Microsoft MSFT, -0.45% and IBM IBM, +0.21% Netflix Inc. NFLX, +1.53% Yelp Inc. YELP, +0.00% CSX Corp. CSX, -1.32% Wells Fargo & Co. WFC, +1.38% and Procter & Gamble Co. PG, -0.64% were also among those listed.
“Investors can buy the closest listed straddles that capture earnings for 6.1% on average, which is just 0.1% above the median 8 quarter earnings move, yet they capture additional trading days,” it wrote.
The fourth-quarter earnings season unofficially starts at the end of this week, with a number of large-capitalization financial stocks reporting, including JPMorgan Chase & Co. and Wells Fargo. Microsoft is scheduled to report its results on Jan. 31, while IBM reports on Jan. 18.
Microsoft has been a market outperformer over the past 12 months, up more than 40%, nearly double the 21% rise of the S&P 500 SPX, -0.11% over the same period. Gains in such large-capitalization technology stocks helped the Technology Select Sector SPDR ETF XLK, -0.35% recently hit all-time highs, topping a record that has stood since the dot-com era.
IBM, on the other hand, has lagged behind amid a longstanding decline in revenue. It is down 1% over the past 12 months, sharply underperforming the broader market and tech overall.