2015 Earnings Season Preview

2014 was a rough year for most active mutual and hedge fund managers, with only 19% of them beating the Russell 2000. Many traders struggled towards the end of 2014 with the pickup in volatility and crashing oil prices, which made it a tricky sideways market to navigate. Many options buyers found themselves whipsawed out of their trades, and option sellers had a tough time navigating the right timing towards the end of the year.

I wanted to turn a new leaf in 2015 and make some adjustments as we enter the 2015 earnings season. We’ve seen AA beat nicely which usually sets the bar for the start of earnings season. I want to delve a little deeper into expectations and point out a few things we’re looking for going into it.

Currently, companies have slashed guidance for this earnings season mostly for 2 reasons. The drop in oil prices are slashing Energy company EPS’s by almost 25% (a huge number) and the strong dollar has had an adverse effect on large multinational companies. Also, it’s noted that consumer spending pickup has not been going at the rate we’d except on the backdrop of lower oil prices. The only place we’re seeing some pickup is the low cost restaurants, hardly enough to make up for the 25% drop in Energy company earnings and higher dollar costs.

This means we’re going into earnings seasons with lowered expectations, which isn’t always a bad thing. Lowered expectations usually means there’s more room for earnings beats, which equates to higher stock prices. This is something we’ve seen for quite a few quarters now, and this one is no exception. However, with the increase of volatility over the last couple of months, we’ve found ourselves needing to be more selective with the stock’s we’re long and short. Early in 2014, picking any strong stock and holding onto it and selling short any weak stock was an easy money maker, it’s a bit tougher in the current environment of elevated volatility.

What we are looking for going into this earnings season is being more selective with our stock and sector selections. Trading mostly quality stocks in strong sectors for our long option strategies. We’ve seen Large and Mega cap stocks outperform the small and mid-cap stocks, which is the flight to quality we saw in late 2014 as traders picked up long term bonds (TLT) like they were going out of style. Look for large cap stocks in strong sectors that clearly have been outperforming with solid financials like AAPL, BBY, LUV, MA, V, OC, INTC, PFE, MRK, WMT, ORLY, and GM. They will likely continue to outperform this earnings season… Healthcare and Consumer Discretionary seems like particularly strong sectors to continue seeing growth this earnings season.

We will look at shorting companies that have clearly lagged the market in weak sectors such as WYNN, TRIP, AMZN, GOOGL, DDD, AFL, BMO, and CL. Financials and Industrials are two sectors that generally have lagged the markets and we are bearish on them going into earnings season.

Lastly we’re going to implement staying away from the energy sector. It seems very tempting to short those energy stocks, and there may still be a good amount of downside left for oil and oil companies, however it is clearly a market that is currently driven more so by emotions rather than fundamentals, which makes it next to impossible to truly gauge. It’s more like gambling rather than trading.

For option sellers, we expect a pickup in volatility going into 2015, however I believe there will still be room to make money on short volatility strategies. I would advise to pay close attention to the VIX as a barometer for closing out short option positions, and reinstating them when VIX crashes down and tapers lower. Also, we recommend rolling out short options positions before expiration as expiration Fridays tends to bring a lot of volatility right up to the end, so if you are selling a 4 week option, you may consider rolling it with 1-2 weeks left into another 4 week option.

Happy Trading!

Tony Zhang
Head of Product Strategy