That special moment has arrived that investing in stocks waits for all year. Earnings season is here. If you're looking for a way to benefit when US stock investing releases its latest results, we have a strategy that could help you do exactly that...
What is the strategy?️
Instead of making our stock investment directly in a company, we can use the stock substitution strategy to buy call options whose «exercise price» is between 5 and 10 dollars below the market price of the stock. Options are typically cheaper than buying shares outright (freeing up cash for other investments), and the prices of these options tend to move in sync with those of the shares themselves.An example: if we buy 100 shares of Alcoa at $50 each, it will cost us $5.000, not counting commissions. If Alcoa shares rose to $55, we would earn $500, or 10% of our initial investment. But if we buy an Alcoa call option with a strike price of $40 for, say, $12, the value of our contract is $1.200 ($12 x 100 shares per option contract). If there is a 1:1 relationship between the stock price and the option price (better known as), the increase of $5 in the share price would increase the value of the option by $5, which would raise the total value of our investment to $1.700 (1.200 + 5*100). This generates a return of 42%, compared to the 10% that we would generate if we had made our investment in shares directly, which in part makes this strategy attractive.
Why use the stock replacement strategy?♻️
Macroeconomic factors such as inflation, interest rates and geopolitics have been the main drivers of equity investment this year. We can see this in the relatively strong correlations of the S&P 500. Investing in stocks has risen and fallen in sync. And this is likely to continue. The three-month correlation for S&P 500 stocks is high, near its all-time high. This tells us that investors have not adjusted their portfolios to account for these single-stock movements around earnings updates. And that means there's a chance for a short-term rebound in stock investing. To be fair, there are factors working against buying call options right now, such as high volatility, which can make them more expensive. But at least one other factor suggests that now is a good time for options-based strategies. Investors are fearful right now as their investment allocation to stocks versus cash is at its lowest point since October 2008.
Stock vs cash allocation. Source: Bank of America
How can we take advantage of this stock investment opportunity?
Luckily for us, Goldman Sachs has made a selection of companies that could be suitable for the stock replacement strategy for this earnings season. They have focused on investing in stocks with liquid options (they can be bought and sold more easily), those that have higher buy ratings and earnings forecasts from the investment bank's analysts compared to rival banks, and those that have underperformed the S&P 7's 500% decline over the past three months.
List of stocks that have generated a return lower than that of the S&P 500. Source: Goldman Sachs.
It should be noted that Goldman excluded investment in energy and materials stocks, whose profitability fluctuates mainly depending on stock prices. investment in raw materials. Some of the biggest names that have yet to report results are Amazon (NASDAQ: AMZN), Atlassian (NASDAQ:TEAM) and Shake Shack (NYSE:SHAK).
To learn how to evaluate these types of opportunities, let's look at Atlassian, based on Goldman analysis. The firm recently upgraded Atlassian Stock to Buy from Neutral on its cloud transition that will accelerate its growth. Goldman says Atlassian has made 15% more profits in the second quarter than other investors expect, and 9% more in the next four quarters.
By Goldman's calculations, the share price could swing 12% in either direction when the company reports results, and likely more if the bank's bullish view on Atlassian's earnings proves true. Furthermore, investor expectations are more negative than positive at the moment, as reflected by the "options bias," which is the proportion of options used to bet on a lower future stock price than a higher one. high.Finally, Atlassian has underperformed the S&P 500 by 16% over the past three months, prompting Goldman to recommend investors buy the August 22 call options at 192,50, $17,30, recently offered at $9 (191,59%, share at $XNUMX). The main risk to be aware of is that buyers of call options risk losing the money paid for the option. That is, the option premium, if the stock ends up below the strike price when the option expires.
Comparison of movements of the last 6 months of Atlassian shares vs S&P 500. Source: Bloomberg