On Thursday, October 18, 2012, Google (GOOG) was scheduled to announce its quarterly EPS numbers after the market close. However, the news was leaked prematurely during regular trading session, almost four hours ahead of schedule. Within seconds, GOOG was down as much as 10% before it was halted.
The GOOG event shows the risk of a sudden and unexpected news event, before a scheduled EPS announcement. This will likely change the dynamics of EPS trading. Typically, investors would wait to place an EPS trade (for example, until the afternoon, for an expected release after the market close). But what if there is another GOOG-type earnings “surprise announcement?”
Going forward, many traders/investors will not go into such events without some sort of hedge. With that being said, long holders of a stock could also buy a put or sell a call option to protect themselves from any downside movement. All trades can be placed before 4:00 PM ET when the cash market closes.
This could be the harbinger of important changes in the coming future. If traders/investors cannot rely on the scheduled time for EPS releases, it will be even more challenging for them to be adequately hedged for such events. This will simply put the credibility of the markets into question and erode trust among investors and traders alike. As a result, implied volatility will increase, which will beget even more volatility for both the markets and individual names. All of this translates into a few key points:
1. Facts will become unknowns, which will ultimately lead to further uncertainty, lack of trust, ambiguity and confusion in the markets.
2. Using option contracts as protection against scheduled events will become more expensive.
3. The spike in options pricing due to volatility will be prolonged, since traders/investors simply won’t have the assurance of the timing of such events any more.
4. As uncertainty increases, the participation in the overall markets will decrease, with fewer players in the game and wider bid/ask spreads.
Conclusion: As traders, we must be more alert and understand how these events are changing the game. As time goes on, events like GOOG might repeat themselves in other individual names. If participation evaporates, volume may decrease, which could make a challenging business more difficult, and retail investors would certainly be affected.
As for options traders, we have to accept higher readings in volatility and be prepared for everything and anything at all times. For stock traders, wild swings and gyrations in the market might keep some traders on the sidelines. The coming days in the market might lead to interesting moves in Implied Volatility for the affected names. All of this translates to possible volatility arbitrage trades. In the mean time, keep your eyes open and stay cautious with an exit plan.