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Financial Stocks Don't Care About Earnings

Where's the Risk?

An earnings event is the collision between the perception of the company and the reality of the company.

Sometimes this collision leads to large market moves.

The options market tries to price that risk-- normally option premiums will rise as we head into an earnings event as the cost to hedge is higher due to higher risk.

We're not seeing that right now.

An Example in JPM

The 14-day Average True Range is at 0.88. This means that over the past 14 trading days, the average trading range is 0.88 up or down.

The Apr weekly straddle is currently going for 1.10. This contract has 1 day left (Friday) and it includes the earnings risk. Using the price/strike formula, we get an expected move of 2.2%.

With the average range at 0.88 and the straddle at 1.10, it tells me that the market is pricing in only 0.22 outside of "normal" volatility.

That is 0.4% extra.

This is silly, and I think buying volatility into earnings is a good idea.

Now I could be wrong. We could be entering a time for financials where volatility disappears as the issues from the EuroZone, TARP and MarktoMarket don't matter anymore and their business models are predictable. It could be different this time.

But from a risk/reward standpoint, the premiums currently being offered are cheap.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/