how to play earnings
Want to know if a stock’s value will rise from its earnings results? Goldman Sachs says the shares’ performance leading up to the event might provide a valuable clue.
After conducting a long-term study of pre- and post-earnings behavior, Goldman’s options department found that “stocks that underperformed in the fortnight prior to the event usually have stronger positive feedback on earnings day.”
More generally, the investment bank observed that stocks more often than not increase in value after reporting earnings, which indicates that a simple options strategy of buying calls on stocks set to report performs well. But selecting only those companies that have slumped into their big day is an even better option.
“On average, call buying on stocks that underperformed ahead of earnings profited 18 percent, which was 4 percent greater than without the filter,” strategists Katherine Fogertey and John Marshall wrote in their report.
What explains the trend?
Goldman puts forward that, “investors reduce stock positions ahead of an event to avoid risk, and reinvest in the stock when the uncertainty of the earnings report is removed.”
By the same token, “those stocks that underperform the most ahead of earnings may have lower expectations, explaining their stronger positive reaction on earnings,” Fogertey and Marshall continue.
This explanation makes sense to David Seaburg, head of equity sales trading at Cowen and Co.
“If there was extreme selling in a name and the news is not as bad as expected, there tends to be a very significant snap-back rally,” he said Wednesday on CNBC’s “Trading Nation.” “Downside sell-offs [and] massive pressure because of fear can really dislocate a name.”
And even though Seaburg would stray from a pre-earnings call-buying strategy alone, he does feel that the market collectively might be primed for a rebound.
“We’re coming into an earnings cycle where expectations are already super, super low and compressed,” he observed.
Goldman: How To Play Earnings Conclusion
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