Stock-option ‘straddles’ aren’t priced for blowout earnings, but they do skew toward the upside
An option straddle on Nvidia’s stock is priced for a move well above its record close after earnings, but that doesn’t mean that’s what is expected.
Investors may have high hopes that Nvidia Corp. will again report strong earnings that propel its stock to record highs. Not so fast, the options market appears to be saying.
The semiconductor company and proxy for the artificial-intelligence boom is scheduled to report fiscal second-quarter results after the Aug. 28 closing bell.
The company has beat profit and sales expectations and provided upbeat guidance for the past six quarters, according to Bespoke Investment Group.
And more recently, the stock soared 9.3% to close at a record high the day after first-quarter results were reported. It also soared 16.4% to a record the day after the fourth-quarter report.
Based on current prices, with the stock surging 4.6% to close Friday at $129.37, it would only take a further increase of a little less than 5% to close above the June 18 record close of $135.58.
Meanwhile, the pricing of an options strategy known as a “straddle” suggests a three-peat might look like a good bet. But if you looked a little closer at how the straddles are priced, you’d see that the odds of a post-earnings record were actually pretty low.
Straddles are bets on the absolute value of a stock’s move after an event, meaning they are not directional. Basically, they’re not unlike an over-under bet on total points scored in a football game.
According to data provided by Matt Amberson, principal at Option Research & Technology Services, straddles are priced for a $12.58 move in Nvidia’s stock the day after earnings, which represents a 9.7% move at Friday’s closing price.
The average post-earnings move over the past 12 quarters is $10.01, which represents a 10.5% move based on the stock price just before the first-quarter report.
Based on Friday’s closing price, a buyer of a straddle would start making money if Nvidia’s stock rose above $141.86 or fell below $116.70.
But keep in mind that the options market is basically like Las Vegas oddsmakers, as it uses recent and expected volatility, time until a specific event and demand to gauge how much investors may be willing to pay for a specific scenario.
And like the house in Vegas, the options market usually wins.
Susquehanna analyst Christopher Jacobson noted that the implied move of a straddle is the weighted average of all the potential moves based on different parameters.
For example, a recent drill-down into the recent pricing of more specific scenarios had put the probability of Nvidia’s stock rising after earnings to $135 — or just below the record high — at 25%, and the probability of its reaching $137.50 at 22%. (The spot price used for Jacobson’s analysis was near Thursday’s close.)
To get to $142.50, which would mean buyers of straddles at current prices would be making money, the options market had put that probability at 16%.
Straddles aren’t meant to be directional, but there is something called “skew” in the options market, in which a bullish or bearish option may be a little more expensive than its respective opposite bet with the same parameters, based on demand.
Susquehanna analyst Christopher Jacobson said that with Nvidia’s options, “the skew continues to appear to be more to the upside.”
He said options had placed about an 8% chance of a selloff of 19% or more after the earnings report, compared with about an 11% chance of a rally of 19% or more.
