- This has been the best quarter for investors to buy call options ahead of earnings ever since Goldman Sachs first started recording returns.
- "We find that stocks have traded up on earnings, even in a challenging market backdrop and when macro has slowed," Goldman's Marshall and Fogertey write.
- Sixty percent of S&P 500 components have reported fourth-quarter earnings, with nearly 70 percent topping Wall Street's profit projections. The reward for topping estimates has been sizable.
A options strategy this earnings season would have netted short-term traders an eye-popping 88 percent return, according to Goldman Sachs. That's the largest return since they started tracking this method nine years ago and well above the 11 percent return it typically yields.
"We find that stocks have traded up on earnings, even in a challenging market backdrop and when macro has slowed," Goldman equity derivatives strategists Katherine Fogertey and John Marshall wrote Thursday. "This magnitude of earnings move is higher than we have observed since the financial crisis."
The strategy is to buy the closest out of the money call option five days ahead of a company's fourth-quarter earnings report and then selling it a day after. Call options are a contract giving investors the right to buy a stock at a strike price within a set period of time. So if the underlying stock price jumps above the strike price (e.g., following a positive earnings result), the trader profits on the difference between the strike price and the market price, the premium, excluding the cost of the option.
That strategy has paid off so far this season, with nearly 70 percent of reporting S&P 500 companies posting better-than-expected profit. The reward for topping estimates has been sizable with big moves coming off those beats. As CNBC noted earlier this month , the average stock performance in reaction to earnings was the best in nine years.
To be sure, options are a contract and can expire worthless so this strategy is not for the faint of heart and mostly used by sophisticated traders who can afford the risk.
What to buy next
Chip stocks including Advanced Micro Devices AMD , Lam Research LRCX and Xilinx XLNX traded up 15 percent or more on their own results, move that proved lucrative to many investors who'd bet on their success ahead of the reports. Call buying in those names was greater than 360 percent on average.
"This quarter, the average tech stock has moved up or down 7 percent on earnings," Marshall and Fogertey wrote. "While they realized a similar degree of volatility this quarter on earnings as last quarter, our analysis suggests a greater degree of volatility this quarter can be attributed to idiosyncratic news on earnings whereas last quarter an unusually high degree of volatility could have been attributed to broader volatility in the sector."
While the major of S&P 500 companies have posted their results, the Goldman strategists offered a few names to trade ahead in the weeks that remain in this earnings season. The team highlighted waste management company Covanta Holding CVA , natural gas producer EOG Resources EOG and Intercept Pharmaceuticals ICPT .
Options investors are underpricing upside potential on both Covanta and EOG Resources compared to the median post-earnings move in the last four quarters, the Goldman team wrote.
— CNBC's Michael Bloom contributed reporting.
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