(Bloomberg) -- A growing cohort of Wall Street strategists says options traders are underestimating how much stocks will swing this earnings season, opening an opportunity for windfall profits for investors willing to bet on fireworks.
Strategies that profit from short-term volatility are near the cheapest in more than a year, according to Macro Risk Advisors. Likewise, Credit Suisse (SIX:CSGN) notes that average single-stock volatility for the biggest 100 names in the S&P 500 Index is lower than it was at the start of the last five earnings seasons.
Those shops, along with JPMorgan Chase & Co (NYSE:JPM)., UBS Group AG and Bank of America Corp (NYSE:BAC). are all recommending that investors seize the opportunity provided by the complacency reflected in the options market.
What all these strategists see is an opportunity to scoop up contracts on the cheap that could pay off handsomely if the market consensus is wrong. And there’s good reason to think it may be. The second-quarter earnings reports will reflect the impact of heightened trade tensions between the U.S. and China, economic data showing a mixed picture on the outlook for growth and the fading effect of domestic tax cuts on corporate profits.
“The options market is essentially pricing the next few weeks to be a snooze,” Mandy Xu, the chief equity derivatives strategist at Credit Suisse, wrote in a note. “That is a mistake, especially as Q2 earnings will give us the first glimpse into how companies are navigating recent trade and macro headwinds.”
Options markets are currently pricing in an average move of 4% for companies announcing earnings, the lowest expected volatility since the second quarter of 2018, according to UBS. In part, that’s because low single-stock realized volatility is suffocating expectations for future swings, Vinay Viswanathan, a derivatives strategist at Macro Risk Advisors, wrote in an email.
JPMorgan says the sanguine outlook is off base.
“We would be generally biased towards being long single-name volatility into earnings,” JPMorgan strategists including Bram Kaplan wrote. The bank’s favored trades for this reporting period include the purchases of calls on Beyond Meat Inc. and Apple Inc (NASDAQ:AAPL). in anticipation of better than expected results and guidance.
UBS strategist Francois Trahan has warned that a large enough decline in forward earnings growth for members of the S&P 500 Index could spell doom for the equity rally -- something that will become evident as corporate America reports results over the next several weeks.
“We expect more implied move beats than last quarter” as a result, UBS strategists wrote in a July 14 note.
Investors saw an example of that Thursday, when shares of Netflix Inc (NASDAQ:NFLX). dropped as much as 12% after a disappointing earnings report, far exceeding the post-earnings move of less than 8% that options traders had priced in.
Low index and single-stock volatility is even prompting some to advocate ditching stocks altogether and loading up on cheap call options ahead of earnings. Credit Suisse’s Xu recommends so-called stock replacement strategies to preserve 2019 portfolio gains without closing the door on further upside.
Bank of America strikes a similar chord, pointing to high-quality stocks like Microsoft Corp (NASDAQ:MSFT). and Mastercard Inc (NYSE:MA). that have become more volatile than the broader market.
“We think a more prudent approach is to rent rather than own upside on select high-quality names, given high-quality stocks have become riskier,” strategists at the bank wrote.
The weapon of choice at Macro Risk Advisors is an options straddle expiring shortly after earnings are announced, a trade that involves simultaneously buying bullish call options and bearish puts. That renders the strategy indifferent to market direction but highly dependent on volatility. If swings are dramatic enough -- regardless of which way -- the strategy will make money.
A so-called “gamma rental” of Twitter Inc (NYSE:TWTR). is among MRA’s preferred ideas, a wager that profits if results from competitors Facebook Inc (NASDAQ:FB). and Snap Inc (NYSE:SNAP). also fuel swings in the micro-blogging social media company’s shares.
