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What bank earnings reveal about the economy, investor outlook

Yahoo Finance’s Julie Hyman, Brian Sozzi, and Myles Udland break down today’s market action and outlook with Stuart Kaiser, UBS Head of Equity Derivatives Research.

Video Transcript

JULIE HYMAN: You're watching Yahoo Finance Live. We are awaiting the opening bell, and we're looking at futures pointing to a lower open after record territory at the end of last week. And last week, of course, also marked the beginning of earnings season. A lot of big banks reporting their numbers this week. We already heard from Coke this morning, IBM after the close. We'll hear from Netflix and Intel, AT&T, and Verizon later this week.

Stuart Kaiser is with us now. He is UBS head of Equity Derivatives Research. Stuart, when you look at the action and the reaction to some of the earnings reports last week, is there anything we can sort of extrapolate ahead, combined with the-- what options are pricing in, in terms of what further earnings reaction we might see?

STUART KAISER: You know, good morning, Julie. I think the big takeaway from last week was, frankly, just relatively high expectations, both on economic data as well as corporate earnings. So the banks put up very strong earnings results, but other than Wells Fargo, all of them moved a lot less than options would have implied. So I think what that's telling you is people are expecting pretty strong results here. And the stock moves have been relatively small, compared to what options markets, I guess, were hoping for.

If we look at this week, about half of the stocks that report this week have implied moves that are much larger than the type of moves they've experienced over the last two years. And frankly, the last two years have been pretty volatile. So that's saying something. So, you know, I think the name of the game right now is fairly high expectations. And, you know, from a risk-reward perspective, that's probably a little tricky. But generally speaking, I think it's consistent with the economic growth we've seen. And investors are expecting strong corporate profits.

BRIAN SOZZI: Stuart, what sectors are investors and traders positioned for big pops or big drops this week earnings and then looking forward?

STUART KAISER: Yes, so the largest moves have been in energy and financials and utilities. Utilities, obviously, a smaller piece of it, but energy and financials were the spot where the implied moves were the largest. And what we saw last week is financials sort of didn't live up to that billing. The areas of the market that are a little more attractive to own options will be technology and communication services, which, frankly, is very refreshing because those tend to be the sectors that people like to trade around earnings for. So, high expectations sort of energy, financials, lower expectations in more of the tech-focused parts of the market.

MYLES UDLAND: Stuart, let's talk a little bit about what's happening along the VIX curve. We've seen, you know, the VIX is now under 20 solidly. And that's a level that we've been watching. But what is that structure telling you about how investors are still thinking about volatility through the rest of this year? And does that have your attention as we get into the second and third quarter here?

STUART KAISER: Yeah, Myles, you know, the curve is actually quite interesting right now. To your point, you know, the front has come down substantially. And that's simply because realized volatility for the S&P has been so low. You know, when you're realizing less than 10% vol, that's going to pull the VIX lower. The rest of the curve, however, is still relatively elevated. You're kind of in the low to mid 20s. We would estimate those parts of the curve are 1 to 3 points maybe higher than you would expect.

And, you know, I think there's probably two primary reasons for that. One is, there's still a fair amount of uncertainty, some related to the vaccine, but also as we get into the second half of the year, will the Fed taper, what will tax and regulatory policy look like, will we get another bout of kind of a China trade war? So I think there's some premium involved in the curve, really, just for those sort of geopolitical risks and some, frankly, just scar tissue.

So I think if you take a step back, you say, in our opinion, the front is a little bit too low right now, but justified by very low realized volatility. And the rest of the curve is telling you that things are a whole heck of a lot better than they were. But there are still enough moving parts out there that the market has been a little hesitant to kind of bring the rest of the curve down to, quote unquote, "normal."

JULIE HYMAN: And, you know, Stuart, you, like us, we've been watching closely the whole retail-driven trend that we've seen this year. Now, a lot of the air seems to be coming out of that, whether it's SPAC, some of the IPOs, although some of the name stocks like GameStop are still roaring along. As you track the options activity, what can you sort of extrapolate about where we are in that cycle?

STUART KAISER: Yeah, I think you hit it on the head. You know, retail options activity has definitely calmed down, I would say, since the end of January. And if you look at the retail cash trading data that we get through UBS, that has also come down substantially. So, you know, to your point, you know, there's still activity in some key stocks.

But by and large, what I would just call tactical short-term options trading activity is down, you know, probably by not quite half, but maybe about a third versus what we saw at the end of January. Now, whether that's positive or negative, I guess it's a little bit hard to know, but I think that's actually one of the reasons that realized volatility for the index at large has also calmed down. There's just a lot less of this sort of short-term risk taking than we saw earlier in the year. And that's had a broader effect on the entire market, I think.

JULIE HYMAN: Yeah, that makes sense. We're setting up for the opening bell in just a bit here. But I wanted to ask you finally about kind of way, way, from the meme stocks, when you're looking at how to position ahead of earnings, I know you have a couple of recommended plays on some big established names, Apple and Activision I'm talking about in particular. You're looking at May call spreads. So why are you pinpointing those two in particular? And why do call spreads make sense going into earnings?

STUART KAISER: Sure, so, you know, the reason that we're interested in those stocks is, frankly, because our analysts have very positive views on the fundamentals. And then if you look at how options are pricing things, you know, the implied moves on those earnings weren't as large as they have in the past. And then in addition to that, we felt like the level of volatility is low enough where you could really get the type of payout and exposure that you wanted.

So, you know, for those stocks in particular, and in general, we like to look for stocks where our analysts have a strong fundamental view and where the options market is also giving you an opportunity. And those two would definitely fall in that category. There's also some stocks in the industrial sector where our data science and big data team see strong revenue momentum in the industrial space. So we're also discussing some stuff in that area of the market as well.

JULIE HYMAN: Yeah, that could kind of feed into the reopening trade that we've talked so much about. Stuart, great to see you, as always. UBS head of Equity Derivatives Research, Stuart Kaiser.