Goldman Sachs: There’s An “Unusually Attractive” Way To Profit This Earnings Season

Goldman Sachs: There’s An “Unusually Attractive” Way To Profit This Earnings Season
Carl Hazeley

over 2 years ago3 mins

  • Buying call options looks attractive right now based on a combination of low option prices, subdued near-term expectations, and elevated pessimism.

  • And it’s been a profitable strategy for years to buy call options ahead of US company earnings and sell them shortly after, earning investors a 13% return on average.

  • The biotech and consumer discretionary sectors – as well as companies like Caterpillar, Coinbase, and Biogen – are especially suited to this strategy at the moment.

Buying call options looks attractive right now based on a combination of low option prices, subdued near-term expectations, and elevated pessimism.

And it’s been a profitable strategy for years to buy call options ahead of US company earnings and sell them shortly after, earning investors a 13% return on average.

The biotech and consumer discretionary sectors – as well as companies like Caterpillar, Coinbase, and Biogen – are especially suited to this strategy at the moment.

Mentioned in story

US earnings season kicked off with the big banks this week, but there’s still time to profit before the rest of the country’s heavy-hitters give you a glimpse behind the curtain. And according to Goldman Sachs, buying call options could be an “unusually attractive” way to do just that.

Why are call options “unusually attractive”?

1. Analysts might be underestimating companies’ performance.

Analysts are expecting US stocks to grow their earnings by 63% on average versus the second quarter last year. And while that’s high by absolute and historical standards, it might actually underestimate just how impactful an improving US economy could be.

2. A relief rally could be on the way.

Data shows that investors have been hedging their bets in case of a broad selloff in the markets. Even modestly better-than-expected earnings growth, then, could drive a “relief rally” as they undo their hedges all at once.

3. US stocks have room to outperform.

The S&P 500 only rose 6% last quarter, but according to Goldman, flows into stock markets over the last quarter suggest the index should’ve risen 15%. According to the bank’s price targets for individual stocks, meanwhile, American stocks should rise about 5% this quarter. These measures suggest US stocks have some catching up to do – and then some.

4. Big price swings are good for investors.

Goldman’s team looked at 25 years of earnings day moves, and found that stock price moves in response to earnings updates are biggest when the economy is going from strength to strength. That works in investors’ favor, since they typically need stock prices to move dramatically for their options to rise in value.

5. There’s a lot more liquidity in the market.

The notional value of options on single stocks was three times higher than the value of shares traded last week (in volumes), and four times the level of two years ago. In other words, more and more retail investors trading options – and more liquidity can only be a positive for the market.

What’s the opportunity here?

Buying call options ahead of earnings season has historically proved a profitable strategy: it’s earned an average return of 13% on the money spent on the calls.

Based on buying first out-the-money calls five days before earnings event, and selling a day after
Based on buying first out-the-money calls five days before earnings event, and selling a day after

Heading into this earnings season, the potential upside is skewed in favor of a few sectors in particular. Biotech and consumer discretionary, for instance, look particularly suited to this strategy right now, so it could be worth focusing your option-buying on sector exchange-traded funds (ETFs).

Implied return on buying Oct-2021 at-the-money calls if major ETFs reach their implied valuations
Implied return on buying Oct-2021 at-the-money calls if major ETFs reach their implied valuations

A higher-risk way to put this strategy into practice is via single stock options. Goldman sees the highest upside to earnings estimates for the stocks below, which should be accompanied by rising share prices (all else equal). Household names include Starbucks, Coinbase, and Caterpillar.

Source: Goldman Sachs, Bloomberg, Thomson Reuters
Source: Goldman Sachs, Bloomberg, Thomson Reuters

Goldman also highlighted stocks where investors’ current positioning suggests a more-than 50% probability of an upward post-earnings move. Names here include Biogen, Schlumberger, and General Electric.

Positioning opportunities

Remember the risks before you dive into call options, though: you could lose your premium (i.e. what you paid for the option) if the underlying shares close below the strike price at expiration.

Even if you go ahead, the returns shown in the tables above aren’t guaranteed. Share prices might move differently to predictions, making your options worthless. And the price and volatility levels are only indicative estimates, so things may have moved when it comes time to buy. Factor in transaction costs on top of that, and your returns could end up being much lower.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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