January 30th, 2022

The Fed Goes Up Against Earnings This Week

We are in peak earnings season with some heavy hitters like Pfizer (PFE), Snap (SNAP), Meta Platforms (META), Amazon (AMZN), Alphabet (GOOGL), and Apple (AAPL) all set to report this week. Some are responsible for a decent portion of their respective index performance, meaning we could see a significant directional move this week in the markets if the individual stocks take off as Netflix or Tesla did.

Stocks have mostly been rewarded for earnings so far despite many offering lower future guidance and plans of scaling back operations to prepare for a recession. Companies like Netflix (NFLX) and Tesla (TSLA) have not only seen their shares rise after earnings, but both companies have been on a massive rebound lately, implying that investors are once again seeking to add risk to their portfolios (both have a beta greater than one). Each has already rebounded by more than 50% from their respective 52-week lows.

What’s the one thing that could stand in the way of another bullish week of earnings?

The Fed is set to announce another rate hike this week. While the market has been planning for a .25% basis point increase, we don’t know what else the Fed has in store for the markets.

I’ve put together a list of the last few Fed announcements and how the SPX reacted that day. Five out of seven events (71%) have been bearish. Six of the last seven had a market move of over 1.5% in a single day. While 14-DEC-22 looks muted in terms of the overall return, the range of that day was still 88 points, which means a 2% intraday move.

I have no idea how the market will respond to the Fed this time around, but everything we’ve seen from the Fed so far isn’t pointing to a pivot. This is the same Fed that said higher rates for longer and while some critical metrics for inflation are showing progress, the last thing the Fed wants is to change direction and have inflation head higher again.

With volatility so low right now, the best way to play a potential market move this week might mean being an option buyer rather than an option seller.

Part of an options price is based on its implied volatility – the market’s forecast of a likely movement in the security’s price.

We’ve seen larger intraday moves, but since October the market has been trading in a range, which has helped IV drop.

That means the cost of options also decreased, meaning now may be a better time to be a net buyer of options rather than a net seller.

A straddle options strategy involves buying both a call and a put at the same strike price with the same expiration date.

For example, if we’re anticipating a 1.5% move in either direction, but don’t know which, buying a SPY (S&P 500 ETF) 10-FEB 405 call and 10 FEB 405 put might help us out. The straddle would cost $11.52, but the expected move of the SPY in two weeks is +/- $11.98. That means this straddle is currently underpriced compared to the expected move.

When it comes to the risk profile in ThinkorSwim, the purple line (profit/loss as of today) is always chasing the teal line (profit/loss at expiration).

That means as more time goes by if SPY doesn’t make a move, the purple line will go lower and this trade will start to lose money. However, if we do get a 1.5% move by the end of this Wednesday, this trade would make about $115. That would give you about a 10% profit in three days.

If you are ok with more risk and are expecting a big move quickly, you can try this with options that expire this week instead, but time is of the essence and would require a significant move to overcome theta/time decay of two purchased options.

You don’t have to hold on to both the call and the put for the same period of time. Since the call and the put are working against each other, you can always cut the loser quickly and hang on to the winner to see if it becomes a runner.

We’ve already talked about the things likely to move the market, but you should be aware that we have a few others to look out for this week.

Consumer confidence on Tuesday.
ISM Manufacturing Tuesday morning.
FOMC Tuesday afternoon (and the press conference right after).
Jobless claims on Thursday.
Employment numbers on Friday.

While each of them is important and can move the market, earnings announcements from the top companies as well as the FOMC Announcement are the two factors that mean the most to me this week.

If you have any questions, comments, or anything we can help with, reach us at any time.
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Jeff Wood

Editor, Filthy Rich Dirt Poor

Trader, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.