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Daily Brief - This is a magical earnings season for option traders (Oct 15, 2021)

There is something that veteran traders surely haven’t missed: the single-stock skew—the difference between bearish put-option and bullish call-option implied volatility—is at the highest level in over a year.


What is going on?


As usual, the options market is a cauldron of coiled anxiety at the start of the third-quarter earnings season, reflecting investor worries about earnings growth. Earnings estimates for the third quarter show little expectation that corporate earnings reports will prove to be much of anything. The elevated skew suggests that investors have bought bearish puts to hedge earnings reports, anticipating headwinds from rising inflation and tough-to-beat comps.


This is the perfect kindling that could spark relief rallies in certain stocks on earnings day, and possibly extend even to broad indexes.


Why are expectations for the earnings season so mediocre?


First, the macro context is tough. The economy is beset by inflationary pressures. Supply chains are struggling to keep pace with demand buttressed by still-expansive monetary policy. Economic growth, the driver of corporate earnings, is showing signs of slowing down after a few stellar quarters. The political drama in Washington doesn’t help although it seems to have been brought to a low boil for now.


There are many crosscurrents in the market, too. The S&P 500 index is near all-time highs. Valuations don’t scream “cheap!”


For option traders, this is the kind of environment that makes careers. An event-heavy calendar where many investors appear to be hedging. This creates the possibility of price-chasing if - as is likely - some of the expectations are beat by solid margins. Goldman Sachs has been advising their clients to look at calls that expire in one month, with strike prices just above the current stock price. This is generally where you can expect the most oomph - your exposure (and profit) will grow fastest if your view is correct.