Earnings season kicks into gear next week with Wells Fargo stock among many of the big bank stocks reporting. Those that are wondering what sort of stock moves we might see can use the options market to gain insight into the market expectation.
Calculating Expected Move On Wells Fargo Stock
It’s shaping up to be a busy week.
So how can the options market help gauge a move in Wells Fargo stock and others? We can use what is called the expected move. This tells us the expected range the market is pricing in for an underlying stock for a specific period.
The quickest way to work out the expected move is to look up the option chain and add together the price of the at-the-money put option and the at-the-money call option. We use the first expiration date after the earnings date.
While this approach isn’t as accurate as a detailed calculation, it does serve as a reasonable estimate.
Let’s take Wells Fargo stock as an example. Earnings are before the open on July 14 so we would use the option chain with a July 16 expiration. The at-the-money call and at-the-money put on Wells Fargo stock are trading just above and below 1.00. The sum of both is roughly 2.05 and that is the expected point move. With Wells Fargo stock trading around 42.50, that’s about a 4.8% expected move.
Remember, that doesn’t tell you direction. It could be either up or down!
Accuracy Of Expected Moves On Bank Stocks
With any forecasting metric, you want to know its accuracy. Let’s take a look at the expected move and the last six earnings reports for some of the bank stocks.
Options on Goldman Sachs stock indicate an expected move of around 3.8%. The last six earnings announcements have seen GS stock stay within the expected range.
Options on JPM stock imply a move of around 3.3%, with the stock also staying within the range after the last six earnings reports.
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Citigroup stock options are pricing in a 4% move. C stock has stayed within the range four out of the last six times.
BAC stock options are implying a 3.9% move. Bank of America stock also stayed within the expected range four out of the last six times.
The expected move for Wells Fargo stock is the largest of the bunch at 4.8%. Historically, this one tends to go outside of its expected range.
Wells Fargo stock only stayed within the expected range three out of the last six times.
Keep an eye on the options market today because rising volatility may see those expected moves increase.
Remember options are risky. Investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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