Sell the Index, Buy the Stocks

01/28/2013 8:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

Apple’s share price dropped 12.4% after falling short of analyst expectations, while Google rose 5.5% after better-than-expected report, which leads Mark Sebastian of OptionPit.com to offer an options play based on large stock moves during this earnings season.

Goldman put out a comment prior to earnings season, which was something that I happened to agree with. It basically pointed toward the fact that, while the VIX was overpriced relative to market movement, it didn't mean the component parts’ IV's were necessarily overpriced. Their main point was that it might not make sense to sell premium in individual names; in fact, they might be a buy. At the same time, SPX IV is probably still a sale. Something that might confirm the low SPX expectations are the overall flat VIX curve and the low JCJ (CBOE Correlation Index). Let's quickly break down the trade.

For starters, the VIX is a sale. Take a look at how well you would have done selling premium in SPX since the 2nd day of the year.

chart
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Click to Enlarge

The JCJ is at post-crisis lows.

chart
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Click to Enlarge

Both of these point towards the SPX not giving much of a hoot about earnings this cycle and probably not moving much.

Now let's look at the straddles of some major names prior to their earnings:

GE

INTC

GOOG

AAPL

NFLX

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In the cases above, we can clearly see that the straddles were underpriced. While I am sure there have been some stocks that have underperformed, I have not heard of many total duds. I am on the other hand consistently seeing big names move hard on earnings. So far, the trend is buy stock straddles and sell SPX straddles. I think that trend continues.

The Trade
If a stock is being talked about a lot and the straddle seems expensive, it's probably expensive for a reason. I am not going short earnings straddles through this cycle. Take a look at buying 'hot straddles' and shorting VIX or SPX straddles.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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