(Bloomberg) -- Here’s how to navigate the rest of the U.S. earnings season, according to Goldman Sachs Group Inc (NYSE:GS).: buy straddles.
Earnings volatility is likely to continue, and the best way to profit from that is to use strategies like buying straddles before companies report, Goldman strategists including Katherine Fogertey and John Marshall wrote in a note Wednesday. The straddle, which involves buying a put and a call on the same underlying stock with the same strike price and expiration date, allows the trade to be less dependent on the overall market direction while still making room to profit if earnings moves exceed expectations.
“With tech, energy and health-care earnings coming into focus, we recommend isolating the potential for larger than expected earnings moves by buying straddles selectively when they cost less than the prior earnings move,” the strategists said.
The volatility this earnings season may be at least partially fueled by the U.S. tax-policy changes, which have presented an “important and idiosyncratic tax reform data point accompanying companies’ earnings reports,” JPMorgan Chase & Co (NYSE:JPM). strategists wrote in a note on Jan. 23. In that analysis, they suggested keeping a bias toward long volatility on U.S. stocks because the tax changes justified a larger risk premium than normal, while the options market was pricing volatility to be in line with the historical average.
Buying calls has also offered unusually big returns amid “robust” earnings moves and the S&P 500’s gain of more than 5 percent this month, the report said. The average stock in Goldman’s universe from a company that has reported this season realized an earnings move of plus or minus 3.6 percent, compared with the two-year average of plus or minus 3.3 percent.
“Buying the closest out of the money one-month call five days ahead of earnings and closing the day after generated a 66 percent return on premium,” Goldman said.