Thursday, January 28, 2010

MSFT & AMZN - Earnings Vol and Skew "Correlation"

MSFT is trading 29.07; AMZN is trading 124.74. Both have earnings today AMC. The LIVEVOL™ Pro Summaries are below.

Note that MSFT IV30™ is 35 vs short term HV measures (10,20,30) all in the 20's. Similarly, AMZN IV30™ is 55 vs short term HV measures (10,20,30) in the high 20 range. Of course, this is simply an expression of earnings vol - since the day of earnings represents a high volatility event.

The Charts Tab snapshot for each (click either image to enlarge) is included below.

The upper portion of the charts are the underlying; the lower portion is a chart of IV30™ (red line) vs HV20 (blue line).

MSFT: We can see graphically the divergence noted above betwen IV30™ and HV20. Further you can see that the level of IV30™ for MSFT is higher than it's been over the last six months - well above the level of last earnings. Also note that MSFT gapped after last earnings, the IV30™ was a purchase but the stock rip didn't blow past the implied move very far.

AMZN: Again we can see graphically the divergence noted above betwen IV30™ and HV20. Also you can see that the level ov IV30™ for AMZN is higher than it's been over the last six months - well above the level of last earnings. But - last earnings the underlying gap was so large, the IV30™ was a purchase into earnings. Note how the blue ine (HV20) gaps well past the IV30™ (red line).

For both stocks, there is a reason for the heightened vol even relative to prior earnings. For a discussion of the "dual" phenomenon, please go HERE.

The Earnings and Dividends Tabs for each stock are included below. Click either image to enlarge. MSFT on top, AMZN on the bottom.

What you're looking at:
(1) The top row is the stock price 5 trading days before earnings through 5 trading days after.
(2) The middle row is the front two month ATM straddles for the same horizon.
(3) The bottom row is the front two month ATM straddle vols for the time horizon.

MSFT: You can clearly see the vol crush (drop) after earnings in MSFT (as expected). You can note that the straddles decreased in value after earnings (they were sales) for the 4/23 and 7/23 cycles. The 10/23 cylce shows the the straddles went up (they were a purchase).

AMZN: Pretty much the same observations. Note however that the last cycle (10/22) the straddles exploded because the stock ripped.

Finally, the Skew Charts for each are included below. You can see the skew for each today (just before earnings) and the skew on 1/7/2010 - "normal" skew. Click any chart to enlarge.

Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month

For both stocks we can see the front month (red) bursting forward as earnings approach. This is expected behavior. For a quick discussion why this happens you can go HERE.

So all this analysis shows us that MSFT and AMZN have behaved similarly over the last 3 earnings cycles and are behaving similarly into this one...

When this type of relationship develops, often times traders on the floor look to make "correlation" bets (or "pair trades"); for example buy one vega and sell the other. Note the term "correlation" is used loosely here - I have not presented a linear measure of relationship. This is all very "touchy-feely" - not really rigorous.

Since the positions offset - the positions are naturally hedged (if they go in the same direction). If a trader is able to pick which vega is a better purchase relative to the other, they can scalp while being hedged. Obviously a ton of other risks are involved - but this is one way we think about it on the floor. Whether or not it's a trading opportunity I leave to you.

Questions to ask yourself: Is there any reason to believe one vol is a better purchase than another? If not, maybe this is simply a "pass on the trade." If yes, maybe not... Are there any other things you could look at other than vol? Are the relative vols similar in divergence?

This is not advice - it is just analysis.

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