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Negative Earnings Reactions and Volatility Dropping

This article is written by Bob Lang, to find out more about
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Earnings Season - Seems Rather Negative

It's hard to imagine such positive results being sold.  We've only had a sampling of earnings so far; by and large they have been met by the market with a thud.  What gives?  It's all about perception and not reality...the perception that future earnings will not be robust or perhaps start to decline in general, rather than the reality of strong earnings being posted and celebrating a good quarter.  Do we dare believe our CEOs when they tell us 'business is ramping', 'backlog is strong as ever', 'production is increasing', 'gross margins are on the rise'?  That's what we've been hearing of late, yet the market is not responding as we would expect.  Oh sure, there are isolated cases of good earnings and a nice pop in the stock:  witness Intel.  The excitement there afterwards bordered giddiness, yet we saw a muted response overall subsequently (in fact, Intel is right near where it was a month ago.  Sentiment has much to do with the response to earnings, and we all know about implied volatility.  But if a company like Intel or IBM beats earnings but cannot get a lift, what does that tell you about sentiment?  Nobody cares about good earnings right now and would use any pop to sell.



Cut To the Chase - Volatility is Dropping

Interesting phenomenon, not too surprising is the dropping volatility.   One recent trend I've noticed is that fear drops soon after the open, and either plunges and works higher or just stays down.  What's it mean?  Simply put we have protection being bought on both sides of the market, perhaps preparing for a big move.  Open interest is heavy on options and contracts out of the money and in future months, and we also see large bets taken on higher volatility.  Sopping up excess volatility is great for the net option seller, capturing premium and waiting for the decay to work in his favor.  I've found that dropping volatility is a good spot to be long (bullish) this market as fear subsides.  However, stagnant volatility is the seller's best friend.

VIX Daily Chart
dtw072010vixa

Always Something to Worry About


Worry, worry, worry.  As Gilda Radner's character Roseanne Rosannadana used to say on SNL, 'It's always something'.  While we cannot pinpoint the exact reason, the sellers are active.  Who needs a particular reason anyhow, when any one will do.  It's summer, markets are struggling, profits are evaporating, and earnings are not driving prices higher.  We have seen good earnings sold viciously - just look at the banks last week for proof.  Markets are not generally moving higher, and traders/investors are still worried about the flash crash scenario happening again...and wouldn't that be a disaster.  But above all this is the economic worries into the next couple of quarters, often the bread/butter for many businesses.  So far, the sentiment is mixed but we'll find out more as the earnings season continues.
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