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Why IBM's earnings miss and subsequent plunge could be good for volatility sellers
So far this month, the market has exhibited extreme fear on just about everything. Everything, that is, except mundane things -- like earnings reports.
Well, that all changed ahead of Monday's open, as we were treated to a miss and a large gap down in International Business Machines Corp. (NYSE:IBM).
OK, news flash: IBM still exists. I have to be honest, I'm not an "IBM-er." I pay it zero attention. But, when I flipped on the Quotron pre-open and saw Nasdaq Composite (COMP) futures unchanged, the S&P 500 Index (SPX) down slightly, and Dow Jones Industrial Average (DJI) futures down a lot, I figured something must have happened in a stock I ignore.
The fear, though, wasn't confined to the arcane methodology of the Dow and the absurd overweighting of stocks with high absolute price tags per share. Rather, it's that IBM's customers are businesses all over the world, so it must speak badly of the global economy.
Either that, or it's earnings management gone awry.
Others will have to carry on that debate. In my world, it matters more what the options expected and how the stock actually performed. And IBM is not a particularly volatile stock, so this move did catch the marketplace by surprise.
Realized volatility in IBM ticked up recently, along with the rest of the marketplace. Ten-day realized volatility was about 19 pre-earnings, one of its highest levels in 2014. Implied volatility via the CBOE Volatility Index (VIX) methodology was 29, which actually was the high this year.
It's tough to isolate what's earnings anticipation and what's simply part of the global volatility lift. But, for what it's worth, my trading system calculated that IBM priced in a 3.5% move on earnings. The gap on the regular open was about 7.5%, so it did cause options shorts some pain.
I wouldn't have called IBM a high-profile name these days before this. It's still a huge and important company, of course, but it's just not a bellwether sort of name in 2014. But, thanks to the gap, it has thrust itself into the forefront of the third-quarter 2014 earnings "book" currently underway. It will bump up earnings premiums on big names yet to report, like Microsoft Corporation (NASDAQ:MSFT) and Amazon.com, Inc. (NASDAQ:AMZN). And it will put global economic slowdown concerns front and center. Netflix, Inc. (NASDAQ:NFLX) was already a high-profile miss, albeit for more company-specific reasons. If you're of the mindset to sell earnings volatility, you likely will get good prices going forward.
As to earnings reaction estimates themselves, keep in mind that they're all standard deviations. And, as such, one in three names will move in excess of the estimate. Perhaps IBM signals something dire that's not fully baked into this earnings season. Or perhaps it's just that we know we will find many anomalies each earnings season, and IBM and NFLX are the first biggies this quarter.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.