Is it possible to strike out three times in the same at bat? That's pretty much how earnings came in this morning. Shortly after the open this morning, we saw 75% of the 20 largest companies reporting last night and 70% of the 20 largest companies reporting this morning, in the red. And there's more than a handful of 7% or greater drops in the crowd. Earnings are certainly not being well received.
Putting blame on foreign currency exchange is still the excuse du jour; however, it doesn't appear to be holding weight, which I view as a positive. This may set up a trap, though, for trading companies reporting in the next day or two. The tendency will now be for investors to take more protective positions into earnings. I would expect to see the implied volatility, especially on the put side of names reporting, to climb higher than what we've seen just before earnings over the past several quarters. Apple (AAPL), VMware (VMW) and Juniper Networks (JNPR) should make good studies later this morning on the thesis.
Why a trap? I believe folks may wind up overly pessimistic tonight going into earnings, believing the easy money is to the downside. If that is indeed the case, coupled with longer-term investors taking a more proactive stance to protecting long positions, and then add in an elevated implied volatility, it could just set us up with a few solid risk-reward plays to the upside. Given the reactions to the reports last night, it would be key to limit risk here, so selling put spreads rather than naked puts, or buying calls rather than buying stock, would absolutely be my approach. If the implied volatility is higher on a name like Apple, then the put spreads rather than calls or call spreads may be the better risk-reward. If the implied volatility is along the same lines of what we saw in 2014, then I'd likely lean towards call spreads or skip-strike butterflies.
The one thing I do not want to see is a big bounce, especially on something like Apple. I'd rather traders be pessimistic. I'd rather not see a buy-the-dip come into play. If we rally into the afternoon, then even pursuing this trading thesis becomes a waste of time, so rather than jump into the number this morning, I'll simply wait until the market slows down around lunchtime to see where we sit. It's a good bet we see one of these big emotional swings early in earnings season where one day everything looks great and the next day the reports results in terrible reactions or vice versa. As we progress through the reports, this phenomena fades. I believe this is the week we'll see it and it would be either tomorrow's reactions or the day following. While it would be nicer to narrow it to just a single day, we have to work with what's in front of us rather than what we believe is ideal.