The options market nailed Tesla (TSLA) almost perfectly. In yesterday’s piece, we analyzed the assumptions that were priced into the TSLA options ahead of its earnings release after the close. The delta assumption was nearly spot on. The highest probability was for a move to the 710-720 area, and we opened this morning at $717.96 Remember that for options traders who actively hedge, the trading around the open is most relevant for success or failure. Active hedgers may be hedging their delta in the post or pre-market sessions, but they can’t easily hedge their volatility until the options market opens. The volatility assumption was a bit higher than the roughly 3% move that we saw, but the market was generally correct that the move would be relatively subdued.
Considering that this week is the main event of earnings week, TSLA proved to be an important opening act. This afternoon we expect to hear from Microsoft (MSFT) and Alphabet (GOOG, GOOGL). Those two companies (three stocks, when we consider Alphabet’s dual share classes) alone make up over 9% of the S&P 500 Index (SPX) and about 17% of the NASDAQ 100 Index (NDX). Big moves in those stocks could have a significant impact on these major indices – especially if they move in the same direction. I believe it would be useful to analyze MSFT and GOOG using the same techniques that we did for TSLA.
Let’s begin with MSFT, the larger of the two companies. This stock had a spectacular run over the past 6 months overall, and most notably over the past few weeks, as evidenced by the chart below:
MSFT 6 Month Chart, Daily Bars
Source: Interactive Brokers
One might expect that traders would be cautious after a move of over 12% in the month leading up to earnings, but that is not what we see in the options market. The Probability Lab[i] display for options expiring on April 30th, the options that are most directly influenced by today’s earnings report, show that the highest probability outcomes are in the 260-265 range, slightly above the current stock price:
MSFT Probability Distribution Using April 30th Options on April 27th
Source: Interactive Brokers
While the curve is not perfectly symmetrical, the area under the curve for below market options is only slightly greater than that for above market options. This shows some risk aversion, but not considerably so. The Time Lapse Skew[Ii] shows a modest downside skew, but not one that shows major fear ahead of earnings. The implied volatility of about 42 for at money options implies a move of just over 2.5%, below the average 3.5% that Bloomberg data shows.
MSFT Skew, April 30th Expiry, Values for April 27th (dark green) and April 26th (light green)
Source: Interactive Brokers
The 6-month chart of GOOG is quite similar to that of MSFT, with a sharp rise in April:
GOOG 6 Month Chart, Daily Bars
Source: Interactive Brokers
Yet the Probability Lab shows greater risk aversion, with the most likely outcomes in the 2265 area, or about 2.5% below the current price. That is more in line with what one would normally expect for a company of this type and size.
GOOG Probability Distribution Using April 30th Options on April 27th
Source: Interactive Brokers
The Time Lapse Skew, however, shows a rather unexpected result. Skews are actually higher to the upside, an inverted condition from what is normally found:
GOOG Skew, April 30th Expiry, Values for April 27th (dark red) and April 26th (light red)
Source: Interactive Brokers
The conclusion I draw for both MSFT and GOOG ahead of earnings is that options traders seem quite sanguine ahead of today’s results, which is surprising for stocks that have risen so sharply in the month leading up to their earnings releases. This tells me that while the most likely outcomes are for relative stasis around earnings, with a slight uptick for MSFT and a slight downtick for GOOG, traders would be quite unprepared if results fail to impress investors. As a contrarian, that makes me a bit wary about the options market’s message ahead of these important earnings releases.
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[i] On your TWS – Analytical Tools -> Options Analysis -> Probability Lab
[ii] On your TWS – Analytical Tools -> Options Analysis -> Volatility Skew -> Time Lapse Skew
Disclosure: Interactive Brokers
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Disclosure: Options Trading
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