Trading Insights
Buckle Up: What Alphabet Earnings Tell Us About Meta
When we published this article on the morning of 10/26, META was trading at $131.74. We wrote about how Meta was likely to plunge on earnings, and highlighted one way that traders could use 2DTE put options to capitalize on the upcoming bearish price action. 10 hours later, the stock had fallen more than 20% to $104.30, wiping out 6 years of gains.
UPDATE, 10/26, AFTER HOURS: When this article was published on Wednesday morning, Meta was trading at $131.74. It’s now after-hours, Meta earnings for Q3 are out (a big miss). Since between the time of publishing and the time of this update, shares of Meta have fallen more than 20%. The bearish put debit spread trade outlined below (which was OTM, and will achieve maximum profit if Meta shares are trading below $120) is now far ITM.
As for shares of Meta, we think Brian Sullivan said it best:
ORIGINAL ARTICLE, WRITTEN 10/26, MARKET OPEN:
Alphabet, Microsoft, Texas Instruments, and a host of other large-cap stocks reported earnings Tuesday night.
The setup heading into those earnings: Heavily green. Between Friday, October 14th and Tuesday, October 25th, the Nasdaq index had risen roughly 8.5% — more than half of that in just the past 5 days. They weren’t alone — all three major indices were up heavily this week.
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Interestingly, Market Rebellion also identified a peculiar occurrence on Monday:
VIX and SPY Correlation: What does it mean?
While it isn’t necessarily the harbinger of doom that many have come to see it as, it’s still an important occurrence to be mindful of. Recall that the VIX is simply a reflection of options positioning, and an indication of the expected size of upcoming SPX moves.
When the VIX and SPX are both rising nearly equal amounts, it indicates that options traders are maintaining caution. This can be a signal of indecision — and much like a reversal candle at the top of a rally — a possible sign of a reversal in the short-term trend.
It makes sense that the options market would begin to get a little defensive at a time like this. Heading into earnings, a big rally like the one above isn’t as bullish as it may seem.
How to Trade Earnings: Goldman Sachs Strategy
Back in 2016, Goldman Sachs published a report about how to predict the likely trajectory of stocks that reported earnings.
What they found: Stocks that underperformed leading up to earnings tend to have positive reactions, and stocks that outperformed leading up to earnings tend to have negative reactions.
“On average, call buying on stocks that underperformed ahead of earnings profited 18 percent, which was 4 percent greater than without the filter,”
Goldman Sachs strategists Katherine Fogertey and John Marshall.
It makes sense for a lot of reasons. When stocks are oversold or overbought, they often don’t even need a reason to reverse some of the move — retracement is just the nature of the stock market. Additionally, as the team of Goldman strategists explain:
“Those stocks that underperform the most ahead of earnings may have lower expectations, explaining their stronger positive reaction on earnings,”
Goldman Sachs strategists Katherine Fogertey and John Marshall.
And likewise, stocks that perform well (like the entire tech sector over the past week and a half) have a higher set of expectations going into earnings. With fresh money positioned into the names, it makes sense that a little bad news can cause a cascade of washouts. And a little bad news is exactly what we got on Tuesday night.
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Alphabet Earnings Miss
Alphabet wasn’t the only one.
Microsoft Earnings Beats, but Cloud Misses
This follows last week’s disappointing release from Snap, another possible signal of slowing ad-spend.
Price Action Following Microsoft and Alphabet Earnings
In short: It looks pretty bad. It’s nothing extraordinary relative to the year that we’ve had thus far, but still, you wouldn’t want to be holding short-term calls on much of anything into this open.
Now, just being overbought doesn’t necessarily mean anything. As economist John Maynard Keynes famously said,
“The market can stay irrational longer than you can stay solvent.”
As we saw above, all it takes is a little push to start a wave of selling. Overbought conditions are like a gasoline leak, and bad earnings news is like the spark that starts the fire. Now, investors will be forced to watch as it spreads to other similar stocks that have yet to report earnings.
What’s Next: Meta Earnings Report Wednesday at the Close
So now we’re up to speed. Stocks rallied pretty hard over the past two weeks, gave some of it back prior to the open today, and now Meta is up to bat. We already know they’re spending a lot on the Metaverse — which has received lukewarm reviews, but is still in the earliest stages of development. Meta has recently said it may take 10 years before that segment of the company is profitable.
That’s not what Meta investors want to hear at a time when margins are already under attack by inflationary forces and supply chain woes. On Monday, Brad Gerstner of Altimeter capital called for the company to cut focus on increasing its margin, in large part by cutting Metaverse spending down to $5B per year.
Despite the name change, the most important number for Meta Platforms doesn’t have anything to do with the metaverse — it’s all about ad revenue. A big win here could defy everything else and send the stock back into rally mode. Unfortunately, based on the information we received from Alphabet on Tuesday, and Snap last week it doesn’t look like that’s in the cards. Apple’s privacy changes continue to hinder Facebook, arguably more than any other company.
Additionally, worries about an economic slowdown do not mix well with ad spending. On top of that, Tiktok continues to grow its audience, broadening its demographic in the process. As of October, 26% of Tiktok’s massive audience is now aged 25-44 — a signal of the app’s grip continuing to strengthen. As screen time continues to be stolen from Meta, as companies cut costs, and as Apple’s privacy changes continue to bite, the setup does not look great for Meta here.
How to Play Meta Earnings
Meta’s average 1-day earnings move in 2022 is 12.41%, and the stock already has a habit of falling after reporting earnings. Earlier this year, Meta took home the record for the largest single-stock loss of market cap in one day, when the stock fell more than 26% following a sour earnings report. The company lost $230B in value as a result.
As of Tuesday’s close, the options market was pricing in an implied move of about 12.2% — indicating that options were fairly priced relative to the average earnings move. However, with volatility surging, and the stock already down significantly, it’s likely that those figures — and the options strategy you may choose — will need to be re-assessed.
Nonetheless, options provide many tools for traders to make any number of predictions. To offset the IV crush that often follows earnings and to cut down on bloated option premiums, options traders could opt for long put debit spreads placed within range of the average earnings move. At the time of writing, with Meta trading currently trading at $131.74, an example of that style of spread would be something like a long $125, short $120 put spread expiring October 28th, which would likely have a rough cost of around $1.80 for a max profit of $3.20. This spread realizes a full profit if Meta makes a move in line with its 2022 average earnings move — from here, that would take Meta down to about $116, giving the above spread a bit of wiggle room.
Of course, this is just one of many ways that traders could choose to play this name. And it goes without saying, any options trade made on earnings is a high-risk one — especially a short-dated move like the trade example illustrated above. However, that’s why earnings provide such attractive risk/reward ratios.
Handle With Care if You Plan to Mettle With Meta
The Bottom Line: Proceed with caution in this name. Bulls looking to establish a position in Meta would likely be best served to wait on the sidelines until the earnings report is released. Bears on the other hand may be able to find an opportunity in the wash of volatility — if Meta’s ad revenue takes the same shape as Alphabet and Snap’s this week.