February 9, 2022

Predicting Moves

One hundred seventy-eight companies reported earnings yesterday. Could one predict which would rise or fall?

There are 148 on deck today, 149 tomorrow.  The high point here in the Q4 2021 cycle was Feb 2 with 330.

Back in early 2016, Goldman Sachs found that stocks underperforming the market in the two weeks before results tended to outperform on the news.  Goldman recommended buying calls on those stocks and found that it returned an average of 18% (that is, buying and selling the calls).

They didn’t say how the stocks themselves fared.

Illustration 35557373 / Earnings © Iqoncept | Dreamstime.com

And there’s no indication the strategy continues to work as it did then.  But you’ll recall that Jan 2016 was pretty volatile.

Not as bad as Jan 2022. 

Bloomberg wrote Jan 31 (thank you, Alert EDGE user John C for the tip) that the market’s capacity to handle trades tumbled during volatility in January. The trouble was so bad that the spread between bids to buy and sell S&P 500 futures contracts widened to levels seen during the Pandemic crash of March 2020.

Nowhere does the article say, as we told all clients, that this same set of futures contracts expired the last trading day of January (and every last trading day of each month), and to prepare for tumult because volatility would make derivatives settlements a hot mess.

Index funds use futures contracts on the S&P 500 to get performance back in line with the benchmark at month-end. They’re an excellent proxy for nearly any basket and “40 Act” funds are permitted by rules to use up to 10% of assets on substitutes.

Tim, I thought you were going to tell us how to know if stocks will surge or swoon on results?

Hang on, I’ll get to that.  There’s an important point here, first.  Futures and options both depend on the value of underlying assets but routinely separate from them.  In fact, stocks in the S&P 500 last week were up 50% more than the derivatives that are supposed to track them.

Stocks comprising the SPX were up 2.3% on average last week, while the SPX, the futures contract, rose 1.5%. That’s a spread of 50% — a crazy divergence. 

Meanwhile, Short Volume hit a record 49% of trading volume in the S&P 500.

It’s all related.

Indexes need to get square. Banks absorb the task, for a fee. Massive volatility ensues. Banks trade like crazy to transfer the risk – they’re not front-running customers but mitigating derivatives risk – from giant gaps and maws in the data to the stock market.

Stocks gyrate. Short volume soars, spreads explode.

And it’s all about derivatives. Not much to do with investor sentiment at all.

Now, can we predict these effects in your stock at results?  Yes.  Not perfectly, but well. Derivatives play a colossal role at earnings, and it can be seen, measured, predicted.

Every public company should measure and observe what the money is doing ahead of results.  Measure what Active money is doing. Check Short Volume. Meter derivatives (we do all of that with machines).

We use that and Supply/Demand data to forecast volatility and direction and to understand the reasons WHY.

For instance, SNAP traded near $24, down from over $83 back in September, before results.  It then skyrocketed after reporting its first quarterly profit to near $40.  That’s terrific, but it’s also crazy.  What kind of market behaves that way?

A story for another day.

Anyway, SNAP showed big LONG bets during January options expirations. The stock price didn’t show it.  But the data sure did.  Short Volume set a six-month low and correlated to a big surge in derivatives (that’s measurable too).

Long bets on SNAP’s earnings.

That didn’t guarantee a big jump. SNAP Short Volume was back to 50% ahead of earnings – a straddle – and currently sits at 61%. But the bets were there.  It was possible to know just about everything that might happen.

If you can know all that, why wouldn’t you? 

If your CEO or CFO knew you could see which way the bets were going, and what was responsible for it, they’d probably appreciate learning about it from the investor-relations officer.  And they’d want to know if money focused on the Story played a role.

Measurable. We can help. Press of a button for us.

I’ll leave you with a tidbit. Statistically, stocks did better reporting AFTER options expirations, regardless of results. Bets cost more.

Public companies, report after expirations. Beware month-end futures expirations. Traders, predictability is better outside options-expirations.

Big lesson? Derivatives are running the stock market.  And data will help you understand the effects.  Don’t go through another earnings cycle guessing at what might happen.

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