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Managing Earnings Risk With and Without Options

In the last couple of weeks we devoted two illustrated posts to the ways one can exploit discrepancies between AI forecasts and market prices. Specifically, we wrote about profiting from the disagreements of (1) “implied moves” priced into stock options ahead of earnings releases, and (2) our AI’s forecasts of post-announcement moves. But today our post will not be about such discrepancies. The reason for that is simple: most companies announcing earnings this week don’t have liquid short-dated options one could take advantage of. And that’s because the majority of them — with a few exceptions like Disney (DIS) and eBay (EBAY) — are too small.

It is in situations like this, when the options markets offer no guidance about the size of the post-EPS stock price moves, our AI forecasts prove particularly useful. Consider an investor with multiple stock positions. As an earnings announcement for a portfolio stock approaches, the investor is aware of the risk that will accompany this news release. Earnings announcements are usually followed by the most volatile day of the quarter, with 10-15 days’ worth of volatility packed into a single morning! Knowing how much you are risking on one stock’s earnings announcement is absolutely essential.

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Investor’s options

What are the alternatives available to the investor? There are three main choices: hold, sell or hedge. How does one choose between them? The investor looks at Proximilar’s AI estimates of EPS and revenues, compares them to the consensus numbers, and does his/her homework. As a result, the investor forms a directional view about the likely quality of the upcoming earnings release. But how much does he/she stand to lose on the investment if things go wrong?

For about 10-20% of US stocks — the biggest and the most liquid — there are two ways to answer this question. One is to look at Proximilar’s AI forecast of the post-earnings move, the other is to look at the options prices and compute the “implied move.” For example, if you own Disney, our forecasted standard deviation of the move is +/- 3.9%, while the short dated options currently imply +/- 3.1%. These numbers are not the same, but for the purposes of risk analysis they are close enough. They tell you that a loss (or a gain) of 3-4% would be entirely unsurprising for Disney earnings, while a one-day loss of 10% or more would be highly unlikely.

When the markets cannot help

This is easy to do with the earnings of a giant company like Disney, Apple (AAPL) or Tesla (TSLA). But what if the stock is one of the 80-90% that don’t have liquid stock options? Consider a company like Madison Square Garden Entertainment (MSGE). It is a sizable company with a market cap of over $2 billion. On average its stock trades a very respectable $20-25 million worth of shares daily. But if you want to know how much the stock is likely to move, the options market won’t be much help. It just is not liquid enough, and there is no options expiry this week.

Proximilar AI’s forecast to the rescue! Our overnight move (standard deviation) for MSGE is forecast at +/- 6.7% this quarter. That is almost twice as volatile as Disney. The irony here is that it is the smaller, more volatile stocks for which investors need guidance that are underserved by the options market. Without our AI, your ability to monitor and manage earnings risk vanishes just when you need it the most.

Excitement and risk

The earnings season is a very exciting and a very nerve-racking period of time for stock investors and traders. The key to profiting from it (and to keeping your sanity) is to never risk more than you can afford. Any loss you take should be small enough that you can get up and fight again tomorrow.

Managing risk is about being humble and acknowledging there are things we simply don’t know. Proximilar AI is an essential weapon in this battle. It allows you to put a number on the risk you are taking and size your position appropriately. Our AI is a professional grade tool that helps you keep your peace of mind while growing your portfolio.

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