Goldman Sachs Touts Volatility Trade Netting 15% on Wild Earnings Days

(Bloomberg) -- A popular volatility trade on Wall Street is netting historic gains as the likes of Facebook parent Meta Platforms Inc. and Spotify Technology SA misfire this earnings season. 

Known as the straddle investing style, managers buy a bullish and a bearish options contract in a company five days before it reports -- and then sell both a day after the event. If shares move far enough in either direction to boost the price of either the put or the call, the strategy makes money. 

Thanks to violent market moves in the new-year rout, it's generated a whopping 15% return on premium so far in 2022 for the average stock. That's five times bigger than the mean since 1996, a Goldman Sachs Group Inc. study found.

And with the omicron-lashed economy weighing on corporate profits, the trade, which involves the same at-the-money strike price for both legs, may have room to run.

“The higher-than-normal moves have driven up the profitability of buying straddles around earnings,” Goldman strategists including Vishal Vivek wrote in a note Wednesday. 

The outsize gain stands out in a market where the S&P 500 has fallen roughly 5% this year, spurred by a newly hawkish Federal Reserve. Volatility erupted as traders struggled to appraise the tightening policy's impact on the economy and corporate earnings. 

With uncertainty over supply chain and wage pressure lingering, earnings reports have been scrutinized to gauge the sustainability of every firm's earnings power. Add on top thin market liquidity that by some measure was the worst since the 2020 pandemic crash, and it's recipe for big swings. 

Among Thursday's violent gyrations, Meta plunged 26% as of 9:40 a.m. in New York as Facebook's user growth faltered in the latest quarter, the first stagnation in the social network's history. Spotify dropped as much as 15% after forecasting a slowdown in its subscriber growth to start the year. 

About half way into this reporting season, at least three other firms in the S&P 500 have seen their stocks moving at least 20% on the first day post earnings. That compared with a total of three for the prior full season, data compiled by Bloomberg show. 

On average, the first-day move post earnings was 3.8% as of Feb. 1, Goldman found. That's above the long-term average of 3.5%.

©2022 Bloomberg L.P.