Monday, April 28, 2014

Management's attempt to inflate a bubble in Apple stock

By expanding its share buyback program, management is influencing investors expectations of an asymmetric payoff.  Using market price to project the business fundamentals is purely manipulating the investors expectations. In addition, by doing a 7 for 1 stock split, management is attempting to capitalize on investor psychology by attracting retail investors towards another potential gain opportunity in the stock. Strength of the company's fundamentals, massive shareholder capital return program, mutual interaction between the underlying trend and investor's bias will lead to divergence of reality from actual fundamentals

My fair value estimate for Apple hasn't changed after the recent earnings release. Recent price movement in the stock has converged the gap between price and value. However, above mentioned management actions and their consequences can possibly mark the beginning of a bull run in Apple, but I don't think it will end in a pretty way.

Saturday, April 19, 2014

Netflix : Options market understating the upside risk into earnings on Apr 21

Is the skew representing true risk associated with Netflix into the earnings. I agree in its current form , skew aligns well with broad market sentiment towards momo- stocks but what if  Netflix reports an improvement in subscriber growth or any other widely followed operating metric. 

Stock which has a history of wild movements after the release of earnings ( good & bad) , this time options market seems not worried about the upside. That indeed got me worried

Wednesday, April 16, 2014

Is Options market pricing the risk correctly in Google earnings

Google is scheduled to report 1Q-2014 earnings after the close of trading on Wednesday, April 16th. For the March Quarter, analysts are expecting earnings per share of $6.41 (Range: $6.00 -$6.83). For FY 2014, analysts are expecting revenue of $66.47 billion dollars implying 11.10 percent year over year growth.
For the last 14 quarters, Google's stock has on an average moved 6 percent, next day after the earnings release. Table below presents how the options market has historically priced at-the-money straddle for Google before earnings (in percent terms, standard deviation terms, and the implied volatility levels). Also included in the table is volatility crush that happens in the options after the earnings are released.

Heading into the earnings this week, the risk reflected by the options market (30 and 60 day implied volatility levels) is marginally lower than the all time highs levels seen last week. For the earnings event , options market is expecting a 5.85 percent move, which is close to the average move in the stock for the last 14 quarters. From an implied volatility perspective- ATM straddle seems overpriced, but appears to be priced fairly on an absolute move basis.
Despite missing the consensus sales estimates in seven of the last nine quarterly reports, market has rewarded Google on the hopes of its multiple revenue streams in future. Besides, the strong growth reported by the Internet software and services industry lifted the growth expectations for Google as well. Decomposing Google Price/ Earning ratio reveals the growth premium built in its stock price. Google stock has lost 13 percent after making an all time highs earlier this year. Even at current market price levels future growth accounts for approximately 50 percent of Google's price.
Implied volatility for long-term dated contracts in Google started to rise before the stock became a victim of momentum reversal in the technology sector. Implied through this divergence in volatility regime from the broader market is the magnification of risk in Google' stock beyond an earnings event.

Earnings Trade
I am quiet intrigued by the fact that Google straddle is pricing only average move heading into the earnings this quarter especially when the momentum stocks have taken a sharp beating. In fact market participants have continued to sell the volatility premium in Google's options since the beginning of this week. Even though I tend to view Google as overvalued at current levels but traders need to be cognizant of the irrational price movement which a growth stock can experience - by elevation of expectations only. 
For the above mentioned reasons and current market sentiments , long volatility offers favorable risk reward . Traders should factor in the volatility crush which the options will undergo after the release of earnings. 
I expect a volatility crush of 3.5 points for June options - exposing 515/575 strangle to a $530 dollars risk if Google does not move.  For September options, I expect a volatility crush of 1.5 points - exposing position to a risk of $250 dollars.  Both these positions have asymmetric payout if moves sharp and fast and these time left to expiry also enables to recover the losses as well. 

Sunday, January 5, 2014

INFY - Setting up Earnings Trade

Infosys historically has shown volatile movements after the earnings release.  Stock has moved close to 8.2% on an average after earnings release for last 12 quarters.  Table 1 below presents the implied volatility levels for first two months before earnings, expected volatility crush after earnings release, stock and at the money straddle performance. 

Implied volatility levels, straddle pricing, stock and straddle performance

Currently, at the money straddle for options expiring on January 18 is pricing a move of 8.4 % in the stock (Close to 12 quarter average move).  30 day and 60 day implied volatility levels shown in figure 4, present fair pricing of options. After converting straddle prices into standard deviation terms, these options seem to be fairly priced as we approach earnings on Friday.