30 Oct Here’s how much the options market expects Apple shares to move off earnings
It’s a big week: a Federal Reserve meeting, unemployment numbers and earnings for the biggest company in the S & P 500. Under “normal” circumstances an FOMC meeting would be the highlight of potential market-moving events, but this is not a normal week and these are not normal circumstances. We now have significant military conflicts in two regions, Europe and the Middle East, and a frosty relationship with China, a superpower expressing expansionist ambitions. Most equity investors will certainly have observed that the S & P 500 , the most cited benchmark of the largest U.S. listed companies, has now declined more than 10% from it’s high of the year in late July, but it is still up 8% ytd. So optimists might cite the past week’s GDP data (+4.9%) as a sign that despite the recent decline in the S & P 500, the U.S. economy is actually quite healthy. The problem is the S & P 500, as a barometer of economic health, much like Pollyanna, skews optimistic by nature of its design. It tracks the largest companies, and it is weighted by market capitalization. The more successful and larger a company becomes, the greater its impact on the value of the index. This is illustrated by the weights of its current largest constituents: Apple, Microsoft, Amazon, Nvidia, Alphabet, Meta Platforms, Berkshire Hathaway, Tesla, UnitedHealth and Eli Lilly & Co. Collectively these represent over 30% of the index. Of these, one could argue, only Berkshire as a conglomerate might indeed be an economic bellwether. The others hardly represent an appropriate yardstick to gauge the health and prospects of US businesses in general. Sentiment numbers don’t jive with the optimism of the GDP data, or the unemployment data, or S & P 500 ytd returns, so what might serve as a better yardstick? Perhaps for guidance we can look to the Russell 2000 index . By contrast to the S & P, the R2K tracks smaller, less well-known businesses. From within this group of companies I decided to look at the year-to-date performance of a subset. First I excluded biotech companies who, as a group, aren’t propelled to success or failure by the strength of the economy, but rather the quality of their specialized innovation. Among this sub-group of just under 1800 companies, only 34.3% are higher year-to-date. The average return for the Russell 2000 excluding biotech companies year-to-date is a decline of 11%. In fact a look at the performance of the index as measured by IWM (below) illustrates that it’s testing 3-year lows. So where does this leave us? I expect the Fed to leave rates unchanged, probably hinting that they still want to give their current policy time to do its work. Even if they do change rates by 25 basis points this way or that, in the grand scheme it wouldn’t represent a meaningful change. History has illustrated that wars are inflationary, and we have a couple. Supply disruptions are inflationary, and we have a couple. In any case inflation can be persistent, which fences the Fed in on one side. Meanwhile household net worth, which rose largely due to transfer payments and money printing, is now falling. This fences the Fed in on the other side. Apple’s implied move So if the Fed is unlikely to cause big market moves this week, what will? For this, as always we look to two things: 1) upcoming catalysts like earnings and 2) what the options market is implying. A common question we get, “How does one determine the size of an anticipated price move is implied by options prices into an upcoming event?” Let’s work through an example together using Apple, the largest constituent of the S & P 500 representing over 7% of the index, that will be reporting this week. A call option represents the right to buy a stock at a specific price known as the “strike price” up until the call expires on its “expiration date”. In this way a call option will increase in value if the stock price rises through the strike price. Consider, the right to purchase a stock for $100 a share has at least $25 worth of intrinsic value if the current market price of those shares is $125 because the holder of the option could “exercise” their right, purchase the shares for $100 and immediately sell those shares at the prevailing market price realizing a $25/share profit. Intuitively then the value of a call option will increase if the underlying stock price increases. A put option represents the right to sell a stock at the strike price. Its value will increase as the share price declines. Consider that the value of a $100 strike put must be worth at least $25 if the market price of the underlying stock is $75 share, because the holder of the put could purchase the shares for $75, and immediately exercise their put option and sell the shares at $100 again realizing a $25 profit. By combining the current value of an at-the-money call option, which gives the holder the right to buy the stock at the stock price until expiration, with the current value of an at-the-money put option, which gives the holder the right to sell the stock at the strike price until expiration, we can calculate how much the options market anticipates a stock could move between now and the expiration date. Lets use Apple , which reports earnings Thursday, as an example. Using Friday’s closing prices for the November 3rd expiration $167.5 call and $167.5 put (the closest strike to Friday’s 168.22 closing price) and adding them together, we get $7.70 as shown in the illustration below. The combination of a long (short) call option and a long (short) put option of the same strike and expiration is known as a “straddle”. In this case the “at-the-money” straddle expiring this coming Friday, November 3rd, is priced at $7.70 or nearly 4.6% of the current stock price. This represents the implied move for Apple by Friday’s close. Using slightly more complicated math we can also establish what the implied move the options market anticipates for the 1 day following the earnings release itself, however for most investors knowing the movement for the week should provide sufficient resolution. Nevertheless, I have included the one-day implied moves in the following list of companies, each of which has seen options volume exceed more than $50 million notionally on average over the past 5 trading days, will all be reporting earnings this week. Note stocks highlighted in green are holdings in our options “Smart Sentiment” strategy DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. 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