The upcoming earnings season is shaping up to be one of the most important in recent memory.
Stocks finally looks vulnerable after almost a decade in bull market territory, and dimming profit outlooks are a big part of that. Investors will be watching closely for signs of a quicker-than-expected earnings slowdown — a development that might make them reconsider owning equities at current levels.
Those cautious investors will be happy to know that Goldman Sachs has formulated an options-trading strategy designed to take advantage of the large price swings that normally accompany first-quarter earnings season.
How big are we talking? Goldman says earnings reports are currently moving stocks 4.4 times more than in average trading, which is well above the trailing 20-year mean. Not to mention the firm finds that more than 25% of annual corporate preannouncements — which are reliably market-moving events — come in January.
So what’s a trader to do? Goldman’s strategy is as follows: An investor buys the closest one-month straddle on a stock five days ahead of earnings, then closes it one day after the report. (Note: A straddle is an approach that involves the simultaneous purchase of a put and a call of the same underlying stock, striking price and expiration date.)
But there’s a catch. In order to qualify for the big returns Goldman has seen, the straddle must cost less than the earnings move being implied by the market. That’s a big qualification that narrows down the universe considerably.
On an average basis, the trade has returned a whopping 24% since 1996, according to Goldman. That’s a fantastic profit for just six days of exposure.
The last remaining piece revolves around which stocks qualify for the trade. To that end, Goldman provides the list of 20 companies below, each of which fits perfectly into the strategy.
With all of this established, it’s important to note that the trade’s success isn’t guaranteed going forward — at least to the outsized degree it’s already enjoyed. The market’s overall tone and direction are key variables in the equation.
But you could certainly do a whole lot worse than implementing a proven strategy that comes so highly recommended by one of Wall Street’s best firms.