Why Now’s The Perfect Moment For Goldman’s Earnings Season Strategy Of Choice

Why Now’s The Perfect Moment For Goldman’s Earnings Season Strategy Of Choice
Carl Hazeley

over 2 years ago3 mins

  • Buying call options looks attractive based on a combination of cautious investors, undemanding analyst forecasts, optimistic analyst price targets, and promising flows into US stocks.

  • 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.

  • 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.

Buying call options looks attractive based on a combination of cautious investors, undemanding analyst forecasts, optimistic analyst price targets, and promising flows into US stocks.

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.

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.

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US earnings season kicked off with the big banks last 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 Goldman Sachs thinks now’s the perfect time to roll out one of its go-to strategies…

Why is now such a good time to use this strategy?

Investors are nervous ahead of earnings.

Investors seem to have their stock market positions well-hedged, which suggests they see higher-than-normal downside risk to share prices this earnings season. And the so-called “put-call skew” – which effectively tracks the supply and demand of sell or buy options on stocks – confirms investors on average are bracing for bad news.

Modestly better-than-expected updates, then, could drive a relief rally among certain stocks and the US stock market overall.

Earnings expectations are undemanding.

Analyst estimates for third-quarter earnings have risen 12% over the past three months, but those expectations are still 2% below second quarter’s earnings (excluding financials). This is a similar setup to the last four quarters, and each of those have seen companies beat analyst estimates in aggregate. That suggests current forecasts have undercooked large companies’ profit potential.

Stronger-than-expected earnings updates, all else equal, drive company share prices higher.

Analysts see more upside to stock prices than at any time since 2019.

Goldman analysts, on average, see 14% upside to S&P 500 stocks right now, versus an eight-year average of just 9%. The last time analysts were this positive was in the fourth quarter of 2019.

Based on how well Goldman’s analysts’ price targets have tracked historically, S&P 500 stocks should rise 6% over the next three months, all else equal.

The amount of money flowing into stocks should push prices up.

Goldman has found that the US stock market’s performance is positively correlated with the amount of money flowing into the stock market. Over the past three months, stock market flows were up about 7% (dark blue line), even as the S&P 500 stayed broadly flat (light blue line).

S&P 500 flows versus performance
S&P 500 flows versus performance

What’s the opportunity here?

These four factors suggest stocks are poised to rally, making now a good time to bet on them using call options. Buying call options ahead of earnings season has proved a profitable strategy in the past: 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

You have a couple of options when it comes to buying call options. You could buy near-term “out the money” calls on individual stocks – specifically those that Goldman thinks have the most potential to rise following their respective earnings updates, including Lowe’s, Starbucks, Carlyle Group, and Uber.

Source: Goldman Sachs Global Investment Research, Thomson Reuters, Bloomberg
Source: Goldman Sachs Global Investment Research, Thomson Reuters, Bloomberg

The jump in their share prices will push the value of the options up, so you can still sell the options on and lock in a profit even if they don’t hit the “strike price” needed to execute.

Alternatively, you could avoid the risk of betting on individual companies by applying a similar strategy to whole sectors. That is, you could buy call options on industry exchange-traded funds. Goldman has compared the price of “at the money” January 2022 call options to analyst price targets, and come up with the sectors where buying calls could pay off the most, including the biotechnology and semiconductor industries. The table below lists the ETFs you’d look to buy options on if you follow this strategy.

ETFs

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.

The returns shown in the tables above aren’t guaranteed either. Share prices might move differently to predictions, making your options worthless. And the price and volatility levels are only indicative estimates, which means things might’ve 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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