- Third-quarter earnings growth is likely to once again surpass low expectations from Wall Street analysts, according to quant strategists at JPMorgan.
- They expect positive earnings surprises to be bullish for the stock market, and compiled a list of their 10 favorite options trades to take advantage.
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Wall Street analysts notoriously set a low bar for corporate America when it comes to quarterly earnings.
The third quarter was likely no exception, according to quant strategists at JPMorgan who anticipate that companies will once again outperform analysts’ conservative forecasts.
Analysts expect S&P 500 companies to post a 4% year-over-year decline in earnings growth in the third quarter. But in JPMorgan’s view, growth will likely be flat and mark a bottom in the earnings decline that has been in place since the first quarter.
The positive earnings surprises would juxtapose widespread fears of an earnings recession — a combo that JPMorgan sees as a bullish catalyst for the market.
The strategists led by Marko Kolanovic, JPMorgan’s global head of quantitative and derivatives strategy, went a step further to lay out 10 of their favorite options trades to profit from earnings season.
All the quotes below are derived from a recent client note and attributable to Kolanovic’s team.
1. Buy Russell 2000 calls or outperformance options into Q3 reporting on value and positioning tailwinds.
“As we argued in our last Volatility Review, Russell 2000 could benefit from a resumption of September’s reversal of extreme positioning between value and low vol styles, and reversal of CTA short positions on a rally.”
2. Buy SPDR S&P Oil & Gas Exploration & Production ETF (XOP) calls given high short interest and as an upside hedge for a Value rally.
“In our last Volatility Review, we also discussed how a resumption of the Value-Momentum reversion would significantly benefit energy stocks. Short interest on the XOP has increased unrelentingly over the past 5 months, and is equivalent to 117% of outstanding float as of the end of September. Given the high short interest, even inline 3Q results risk sparking a short-covering rally.”
3. Buy Technology Select Sector SPDR Fund (XLK) calls — volatility is cheap and single-stock earnings could drive upside.
“Fundamentally we have an upside bias to 3Q earnings for Microsoft, Apple, Visa and Mastercard, and the sum of their weighting alone makes up ~48% of the XLK.”
4. Buy GM puts — earnings carry elevated headline risk.
“As a short-term strategy into earnings, we recommend investors purchase General Motors November 8th (weekly) 35.5 strike puts for $0.82, indicatively ($35.93 reference price). Our analyst sees GM missing earnings, owing to a number of moving pieces for the quarter, which we believe are likely to create above-average earnings-driven volatility.”
5. Buy Royal Caribbean Cruises calls — poor sentiment and muted expectations set a low bar for an outsized earnings move.
“We recommend investors purchase Royal Caribbean Cruises November 8th (weekly) 113 strike calls for $2.00, indicatively ($112.07 reference price), as muted Street expectations, poor sentiment, and an earnings multiple at a multiyear low, set a low bar for 3Q which we believe will be a positive catalyst.”
6. Buy Newell Brands straddles — earnings volatility is cheap.
“We recommend investors purchase Newell Brands November 20 strike straddles for $2.25, indicatively ($19.92 reference price), taking advantage of NWL’s cheap earnings volatility, while the setup may make for a volatile quarter.”
7. Buy bull risk reversals on Microsoft — fiscal-quarter 1 may spark a break out in the stock but earnings volatility is rich.
“We recommend investors purchase Microsoft November 1st (weekly) 135p/140c bull risk reversals for $0.82, indicatively ($138.43 reference price). This structure assists in reducing the impact of the stock’s elevated earnings related volatility while maintaining our positive directional view on the stock following JPM’s favorable FQ1 Partner Survey.”
8. Buy AMD straddles — volatility is cheap yet impactful guidance is forthcoming.
“We recommend investors purchase Advanced Micro Devices November 1st (weekly) 32 strike straddles for $3.32, indicatively ($32.03 reference price), as we believe the market is not incorporating enough risk premium to earnings given the potential impact AMD’s 4Q guidance may have on the stock.”
9. Buy Xilinx straddles — volatility appears cheap ahead of its anticipated 2020 guidance.
“We recommend investors purchase Xilinx November 1st (weekly) 95 strike straddles for $7.55, indicatively ($95.06 reference price), taking advantage of the stock’s cheap earnings volatility as uncertainties surrounding Huawei, the macro environment, and its FY20 guide are likely to make for a volatile quarterly report.”
10. Buy Square straddles — earnings volatility appears rather cheap given the importance of the quarter.
“Given the macro uncertainties (i.e., strength of the consumer, impact on small business from trade etc.), and potential importance this quarter may have as it relates defining a direction of the stock into year-end, we believe the current option implied move to be conservative.
“We recommend investors purchase SQ November 8th 61 strike straddles for $6.30, indicatively ($61.15 reference price).”
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