By some measures Naz’ 100 (QQQ) constituent and internet giant Google (GOOG) blew past Street estimates. Headline earnings of $10.08 per share versus forecasts of $9.64 amounted to being an easy beat. Analysts were a good deal closer to the truth on the top line as the company reported revenues of $8.14B versus views of $8.15B. And on other quantifiable fronts, namely traders’ collective voting power for the stock’s expected move; the reality is setting up to be quite the substantial miss, much to the chagrin of long premium strategies.
Based on Google’s closing Weeklys April straddle and strangle markets and what amount to as the purest non-directional play on earnings-related movement, we can, through a couple methods / techniques, see what traders were pricing in for shares of GOOG and compare that to the actual reaction in the stock. So far and in the premarket, straddles and strangles, and what amount to as an over / under line of sorts, look well off-the-mark and a huge boon for short premium strategies, due to the large, but tiny percentage surprise in shares.
While it’s not over ‘til it’s over, the end game for the Weeklys is certainly near with just more than a handful of hours until the clock officially winds down to zero. Unofficially speaking, we’d expect a forced expiration by traders or contingent exit plan to be worked out in the first one hour to avoid what could be a full-fledged siphoning of purchased premium due to combined volatility crush and theta.
Figure 1: Google (GOOG) 1x Weeklys April 650 Straddle
So, what were expectations like entering the earnings event? With shares finishing Thursday at 651, for all intents and purposes, the Weeklys April 650 straddle was virtually built of 100% pure time premium and a fairly large amount at that with a price tag of $40.15 per spread. Percentage wise, the pricing reflects a required move by Friday’s closing bell in excess of 6% to breakeven. Given post earnings moves of -8%, +13%, +6% and -8.5% over the past year, the spread was actually priced a bit cheap.
At the same time, that type of edge and as a long straddle holder faces now, there’s also little margin for error when playing the event in this capacity. With shares currently under a modest 0.40% of pressure in the premarket, the straddle’s intrinsic value is less than $2.00 and would probably maintain another $3 to $4 of extrinsic premium out-the-gate, but at risk of losing that value by the close were shares to finish there. It should be noted, a trader that does find themselves in this sort of under pressure situation may try and work through some of the premium damage by scalping stock / hedging deltas during the course of the day.
For instance and a very simple illustration, if shares, up to 100% of his or her contract holdings were purchased below the strike price and then later on in the day, sold above the strike if GOOG reversed higher; the trader would have a profitable stock scalp on their hands which would partially offset the loss in straddle value. Were enough of these type adjustments made, theoretically, the straddle could lose 100% of its worth with shares closing right at the strike, yet the trader would have an overall profit due to the scalping; albeit very savvy and highly unlikely maneuverings.
Another way of determining an estimated move is to average the at-the-money straddle and strangle markets. If contract volume is more or less evenly concentrated in these strikes we might surmise this method makes additional sense as it better represents a reflection of where traders were actually placing their bets versus a more hypothetical “that’s what they were thinking” situation. With the straddle priced for $40.15 and the surrounding money 640 / 660 fetching $30.00; we can do the simple math and fudge an expected move value of $35 or 5.35% and slightly less than our calculated 6% estimate using just the straddle market.
A third method regarding expectations for the reaction in shares is to use the bell curve and its associated probabilities using standard deviation analysis. This is based on the idea of implied volatility being tied to a “1 SD” calculation or confidence of 68% on an annualized basis. In order to take raw implied volatility data to come up with a workable figure for a shorter period, as with Google’s Weeklys pricing, traders can use the following steps:
- Divide yearly calendar days by days until expiration: 365 / x = y
- Take the square root of “y”
- Divide current implied readings by step 2 to yield percent move estimate.
- Multiple step 3 by underlying share price to determine up / down price range estimated at 1SD confidence
With just one day on the calendar and implieds of about 150%, as of Thursday evening we can calculate a value of 7.85%. This suggests the option market is expecting a 68% chance GOOG will stay within 7.85% of 650 through Friday’s close. This figure is quite a bit higher than the other methods used to determine the expected move. We attribute the difference to its more theoretical roots and one wherein the concept and use of continuous hedging is factored in. An hour into Friday’s session and shares of GOOG now off nearly 3.0%; expectations are still looking only about half right by some measures and less so by others, in an otherwise and always imperfect world of pricing.
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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