U.S. stocks’ volatility expectations muted ahead of earnings

By Saqib Iqbal Ahmed

NEW YORK (Reuters) – Investors are staring at the first quarterly decline in U.S. corporate profits in six years – but the message coming out of the options market for now is not to worry.

Earnings reporting seasons are typically choppy periods for stocks, but the number of S&P 500 companies expected to see a jump in volatility is lower than where it stood a year ago or even at the same point in 2013, according to a Reuters analysis of options data.

That does not mean that investors are throwing caution to the wind. The S&P put-to-call ratio favors puts by about the highest margin over the last two years, in a sign of demand to hedge risk in the market as a whole.

But when it comes to individual stocks, expectations for volatility have dimmed as investors bet on fewer big price swings in specific names for the next two months than have been seen in the last two.

Investors’ calm can be explained by the already drastic downward revisions in earnings expectations thanks to the strong dollar, a tepid macro environment and – for the energy sector – lower oil prices. But it could still be setting them up for a rude shock, said Steve Sosnick, an equity risk manager at Timber Hill.

“There appears to be a complacency that may or may not be justified,” Sosnick said.

Of the 350-or-so S&P 500 companies that are expected to report results in the next five weeks, about 55 percent are expected to see higher volatility in the next sixty days, compared to moves in their shares over the last sixty.

That’s much lower than the last two years, when investors expected a jump in volatility for more than two-thirds of these companies.

For example, Facebook Inc, which is expected to report results on April 22, is expected to move by about 7 percent, in either direction, by April 24. That stock moved 9 percent for the same period last year. The implied move could shrink further as the date for the results nears, as it typically does when options approach expiration.

Part of the reason investors are less concerned is that earnings expectations have already been sharply reduced. The first quarter is expected to see a 2.8 percent drop in earnings, down from estimates of 5.3 percent growth at the start of January.

“There is a lot of negative adjustment already baked into the cake,” Andrew Wilkinson, chief market analyst at U.S. electronic broker Interactive Brokers LLC, said. “It would, therefore, take bigger misses to unsettle investors.”

To others, though, it suggests that investors are under-estimating the chances of negative surprises at specific companies and thus making themselves vulnerable to sudden shocks.

“I think it’s absolutely remarkable that the option market is asleep,” said Ophir Gottlieb, chief executive of Los Angeles-based Capital Market Laboratories.

“The strong dollar, weak oil and slowing GDP growth are all factors of risk that seem underappreciated right now,” he said.

SOME BIG MOVES EXPECTED

To be sure, some companies’ investors are poised for the worst, especially those whose earnings growth estimates have been drastically lowered in recent months.

One area where investors are preparing for a wild ride is the energy sector, which has been bruised as oil prices plunged and analysts sharply throttled back expectations. The consensus is now for a 64 percent decline in sector results, according to Thomson Reuters data.

Within that sector, investors see oil drillers as candidates for particularly elevated volatility.

Diamond Offshore Drilling Inc’s shares, for instance, are expected to move 13 percent, in either direction, by the middle of May. Last year, the shares ended up rising 4 percent between the first week of April and mid-May.

Even so, it remains unclear whether investors have factored in sufficient weakness for such companies. Last quarter, offshore driller Ensco Plc’s shares fell 8 percent to a six-year low after it reported a loss and slashed its quarterly dividend by 80 percent.

“You would think that the expectations have probably been lowered sufficiently for them, but perhaps not,” Randy Frederick, managing director of trading and derivatives for Charles Schwab in Austin, Texas.

On the other side of the equation, financials, which are poised to show the strongest first-quarter growth, are showing lesser expectations for a jump in volatility.

Companies including Bank Of America Corp, T. Rowe Price Group Inc, Morgan Stanley, and BlackRock Inc look poised for lesser-than-usual stock price moves after they report earnings.

(Reporting by Saqib Iqbal Ahmed; Editing by Christian Plumb)