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  • Writer's pictureThe San Juan Daily Star

Options bets on earnings-fueled volatility in US stocks paying off

An options strategy that bets on stocks logging larger-than-expected moves on corporate results has been a surprising winner this earnings season, data from options analytics service ORATS showed.

Buying options straddles on U.S. companies reporting results over the last three weeks - a strategy that combines a put and a call option - is paying off this quarter, ORATS data showed.

Calls convey the right to buy shares at a fixed price in the future and puts offer the right to sell shares. Owning both these contracts is a way for traders to profit from larger-than-expected post-earnings stock swings.

For the last three weeks, options straddles on U.S. companies reporting results fetched an average return of 8%, ORATS data showed. That compares with an average return of -2% over the last 12 quarters.

“It is not usual for straddles to pay off,” ORATS founder Matt Amberson said, noting that the strategy has tended to be a slight loser in recent quarters.

Generally poor expectations for stock gyrations at the start of earnings season - the Cboe Volatility Index hovered near a more than 3-year low as earnings kicked off - may have helped set up the trade favorably by making it cheaper for investors to bet on heightened stock moves.

With volatility expectations low, stocks handily topped options-implied moves as earnings season progressed.

That, however, may be changing, Amberson said.

As volatility has picked up, these bets have become more expensive, making it harder for the strategy to post a win.

Of the 422 companies in the S&P 500 that have reported earnings as of Aug. 4, 79.1% beat analysts’ expectations, the highest rate since the third quarter of 2021, I/B/E/S data from Refinitiv showed.

Now that regulators in Washington have unfurled a hefty reform package of post-financial crisis capital regulations, banking industry advisers are honing in on what they consider most disruptive, including risk management requirements that could affect real estate lending, consumer credit and wealth management.

In a joint proposal on July 27, the top three U.S. bank regulators proposed a thousand-page overhaul that would in aggregate require banks to set aside an additional 16% in capital the regulators believe is needed to strengthen the financial system.

By increasing the degree of risk attributed to certain assets, the proposed rules would require banks to hold proportionately more capital, potentially eating into returns on equity and profits. Industry lobby groups such as the Financial Services Forum (FSF), the Bank Policy Institute and the Securities Industry and Financial Markets Association have argued this will make it harder to lend to consumers and warn it will slow the economy.

Though the spring of 2023 saw three of the four biggest bank failures in U.S. history, the FSF reacted to the proposal by saying the Federal Reserve’s own stress tests show the largest banks were sound and well capitalized, making the proposal “a solution without a problem.”

Industry analysts see areas which the well-financed bank lobby will be eager to red-pencil.

Joe Sass, senior vice president for balance sheet risk at financial services conglomerate FIS, said the proposal’s shift from a standard risk charge to a range of risk levels to be allocated to different assets for rental-backed real estate lending would likely be “circled for push-backs.”

Making such lending more expensive will shrink credit available to historically under-served borrowers, something the industry is likely to fight, he said.

Chen Xu, an attorney in the financial institutions group at Debevoise & Plimpton, said the new rules viewed high-revenue business lines as higher risk.

“Some businesses that are fee-based such as wealth management will need to allocate more capital even if there is no balance sheet risk,” he said, adding that this could weigh on trading in capital markets.

Reform proponents argue the true danger to public welfare is financial instability.

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