Want to know whether a stock will rise on its earnings results? Goldman Sachs says the shares' performance going into the event could provide a valuable clue.
After performing a long-term study of pre- and post-earnings behavior, Goldman's options team found that "stocks that underperformed in the two weeks ahead of the event tended to have stronger positive reactions on earnings day."
More generally, the investment bank noticed that stocks tend to rise after reporting earnings, which means that a basic options strategy of buying calls on all stocks set to report works well. But selecting only those names that have tumbled into their big day is an even better play.
"On average, call buying on stocks that underperformed ahead of earnings profited 18 percent, which was 4 percent greater than without the filter," strategists Katherine Fogertey and John Marshall wrote in a Wednesday report.
What explains the trend?
Goldman posits that on the whole, "investors reduce stock positions ahead of an event to avoid risk, and reinvest in the stock when the uncertainty of the earnings report is removed."
Along the same lines, "those stocks that underperform the most ahead of earnings may have lower expectations, explaining their stronger positive reaction on earnings," Fogertey and Marshall continue.
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Such an explanation makes sense to David Seaburg, head of equity sales trading at Cowen and Co.
"If there was extreme selling in a name and the news is not as bad as expected, there tends to be a very significant snap-back rally," he said Wednesday on CNBC's "Trading Nation." "Downside sell-offs [and] massive pressure because of fear can really dislocate a name."
And while Seaburg wouldn't pursue a pre-earnings call-buying strategy per se, he does believe that the market as a whole could be set for a bounce.
"We're coming into an earnings cycle where expectations are already super, super low and compressed," he observed.
