Part 2: It was a low key earnings season - yes it was

by Wayne Ferbert on September 5th, 2013

In Part 1 earlier this week, we showed how the average response to earnings announcements this quarter was ‘muted’ compared to the prior quarter. Stocks did not ‘react’ to earnings news on earnings day in a manner consistent with recent quarters.
While there was the same number of significant outlier movers in both quarters, their were many more stocks this quarter that moved very little. If you go back to our blog post, in the Q2 earnings announcements, we saw 52% of the stocks close the day with a move less than 2.5% in either direction.  In Q1, only 44% of stocks moved by less than 2.5%.
We have been using a nice web site called which tracks earnings surprises and the options price expectations for earnings.
So the obvious question becomes: what did the market expect was going to happen in Q2 compared to Q2? The answer: the market priced in roughly the same earnings move expectations in both quarters. In other words, the market did not expect any more/fewer earnings surprises this quarter (Q2) than last quarter (Q1).
So, with fewer surprises, the options trader that traded on earnings needed to be right in his proposed direction for the stock movement. The options market extracts a lot of ‘rent’ from the investor for the ability to make a play on what will happen in earnings. The time value the day before earnings is significantly higher than the day after earnings. The average ATM option loses between 1-2% of time value between those two days.
If the market doesn’t oblige and provide significant moves, then the options investor cannot make up for the cost of the time value paid. This past quarter, the anyone selling the ATM options prior to earnings had a much better quarter than those that bought them.
The straddle is the tactic in which the trader says: I don’t know what direction the stock is going to move in – but I think the move will be big in one of the directions.
Optionslam tracks the options prices aroung earnings for about 1000 stocks with a price over $10. When we examine that list for Q2, we find that only 26% would have made a profit with a straddle. And the average straddle profit across all 1000 was -12.5%.
In the prior quarter, 31% of the list made a profit on a straddle and the average profit across all 100 stocks on a straddle was -7.3%.

Note for the reader: the straddle tactic will ALWAYS be a loser when measured across this large of a population. However, the extent to which we see losers and how often we see them gives you an idea about how many companies surprised and to what degree they surprised.
When we examine only the stocks that turned a profit on the straddle, we see an interesting trend. In Q2, of the 26% of the stocks that turned a profit on a straddle, we see an average profit of +40% per trade! In Q1, of the 31% of stocks that had a profit on a straddle, the average profit was +45%. In the world of straddle returns, this is very close.
The straddle trades that were profitable are the real outlier movers – because they must overcome TWICE the time value cost to make a profit. But with similar returns, can we glean anything from this?
We did see that the outlier movers in Q2 tended to have a materially higher Implied Volatility than the Q1 straddle profiteers! This is where the data gets interesting for me.
When I combine the muted stock moves – but the similar implied volatility paid across the entire list, we definitely find a quarter in which the surprises in earnings were hard to come by. In addition, it is interesting that the average straddle in Q2 to turn a profit was a higher Implied Volatility than the same trade in Q1. That means that the surprises are starting to come more often from the smaller and mid-cap companies that trade with higher implied volatility. This is where you expect to see surprises. This is what a normal market would expect.
What does a muted move on earnings mean along with a more normal price movement from stocks with higher IV? It means that the market has priced stocks fairly right now – and wasn’t impressed or depressed much by the most recent earnings. In the end, that might best explain the recent tops the market put in here with the end of earnings season.
Earnings season was not the further catalyst for stocks that some had hoped. Time to be cautious as in the end, a stock is only worth some discount of its future earnings power. If that power is topping out, then so will the stock market.

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