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Options on Financials are Underpricing Earnings Risk

January 14, 2013 By Steven Place

There are 18 large-cap financial stocks that report earnings this week.

financial-earnings

Many of these companies have been leading the market higher, so we have to pay attention to the price action in these names post-earnings.

There is the possibility of short term risk in the financial sector-- but is the options market already pricing it in?

Complacent Options

But let's take a look at the 30 day implied volatility of XLF:

xlf-implied-volatility

We're right near 52 week lows-- and while the realized volatility has often traded much lower than a 16% reading, it seems as though expected volatility through earnings season is non-existent.

The single stock risk is not pricing in wild moves either. Implied volatility for JPM and GS are trading near 52 week lows as well.

A quick look at the technicals of XLF shows an ascending channel after a gap higher:

xlf-daily

If any surprise number comes out of any of these big banks, it will cause the XLF to break the trendline and attempt a retest at that gap.

What This Means for You

If you are long financials, insurance into earnings is pretty cheap. Consider moving to protected puts, or doing a call conversion on long stock.

If you are trading earnings, blindly selling premium is a terrible idea here. Focus more on long gamma and long volatility opportunities in this market.

If you think financials will move this week, the Jan 17 straddle is trading for under .30-- this means to be profitable at options expiration, you need to see a .30 movement either up or down. Last week's range was .29, without any earnings events.


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