Thursday, July 20, 2017

U.S. Stock Options Attractive As Earnings Reports Roll In

By Saqib Iqbal Ahmed
Reuters
July 20, 2017

The U.S. equity options market is pricing in uncharacteristically low stock market gyrations in the early days of second quarter corporate earnings reports, offering attractive opportunities for investors, market analysts said on Wednesday.

On Wednesday, the CBOE Volatility Index .VIX, better known as the VIX and the most widely followed barometer of expected near-term stock market volatility, closed below 10 for the fifth straight day, the longest such streak since its inception.

This expectation of extended calm for stocks in the near-term flies in the face of how much stocks tend to move on earnings reports.

For example, when S&P 500 companies reported earnings during the first quarter, the average stock's one-day price move was four times greater than during non-earnings trading, according to derivatives analysts at Goldman Sachs.

"Stock volatility has shifted more into the earnings report and out of non-earnings periods - yet the options market has not adjusted to reflect the increasing importance of earnings for stocks returns," Goldman analysts said in a note on Wednesday.

"We view this set-up as very supportive of buying options ahead of earnings."

While subdued expectations for volatility has led to attractively priced options contracts across the board - whether investors are looking to hedge or to speculate - the pricing on contracts that profit from further gains are particularly appealing.

"The premiums on upside call options have gone very, very low and they are worth buying," said Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors in New York.

Just how cheap these options are can be gauged by their delta, a proxy for the market's implied probability that a contract will be profitable at expiry.

As of Wednesday morning, one-month S&P 500 call options that make money if the index rises above 2,500 by expiry were pricing a less than 6 percent chance of success, a record low probability, according to Chintawongvanich.

Calls convey the right to buy shares at a fixed price in the future, while put options give the right to sell shares at a certain price in the future.

"Going by history, the probability of rallying that much should be much higher," Chintawongvanich said, adding the probability should have been closer to 13 percent, even in a low volatility environment.

On Wednesday, the S&P 500 Index closed at a record high of 2,473.83, taking year-to-date gains to 10.5 percent.


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