Portfolio Beta Hedging Ahead of Super Seven Earnings

4月22日

You cannot predict the future. But you can prepare for it. Mega cap tech stocks have collectively lost USD 930 billion in value since Nasdaq 100 peaked on 21st March 2024. Will Super Sevens earnings turn the tide?

Starting this week, the Super Sevens will start announcing first quarter results. TSLA is up first on 23/Apr (Tue) followed by META on 24/Apr (Wed) with GOOGL and MSFT on 25/Apr (Thu).

AAPL reports on 2/May followed by NVDA on 22/May.

Broad US equity markets are facing multiple headwinds. Rate cut hopes are fading. Geopolitics are turning for the worse with tensions escalating in the middle east. Investor sentiments are gloomy. Consequently, both S&P 500 and Nasdaq 100 have endured their worst week in a long time.


Investors are pinning hopes on AI-infused tech earnings to stem the downdraft and to turn the tide. Bloomberg reports that Super Seven earnings are forecast to rise 38% during Q1 2024 compared to a year ago. If true, those earnings would dwarf the overall S&P 500’s meagre +2.4% forecasted YoY earnings growth.

This paper is set in two parts. Part 1 summarises idiosyncratic factors affecting each of the Super Sevens. Second part of the paper illustrates beta hedging using index options to help portfolio managers defend against downside risk while retaining upside potential.

ARTIFICIAL INTELLIGENCE. EXCITEMENT TO EXHAUSTION?
AI hype remains palpable. But monetising AI is hard. That is becoming increasingly clear. Even among the Super Sevens, not everyone has cracked the AI monetisation formula.

Investors are starting to moderate AI linked expectations. They need a clear path to profits from AI initiatives. Investor scepticism is showing up even among Super Sevens.


NVDA has been selling shovels to AI gold miners. Expectedly, their earnings and consequently their stock prices are up sharply. Its share prices are up 54% YTD leaving the rest in dust. META is up 36%, compared +10% for GOOGL and +6% for NASDAQ:MSFT.

AAPL and TSLA are increasingly losing shine. TSLA (down a colossal 41%) risks being booted out of the Super Seven grouping.

“Investors are expecting not just strong results — but strong guidance,” said Quincy Krosby, chief global strategist at LPL Financial. “Any disappointment from the mega-tech names reporting could push this week’s oversold market deeper into oversold territory” as reported by Bloomberg.

AMZN is expected to deliver modest EPS growth.


Analysts remain strongly bullish with 60 of 63 analysts giving a Strong Buy or Buy rating.

Source: TradingView

GOOGL is facing justified scepticism by investors about its AI capabilities after multiple missteps. AI powered search engines potentially threatens Google’s dominance.


Despite the headwinds, analysts remain bullish on GOOGL with average 12-month price target offering an 8% upside.

Source: TradingView

Falling smartphone market share, slowdown in innovations, nothing to show for in AI, lacklustre demand for Vision Pro, closure of Apple Car project, Anti-trust fines and more. Adverse news is hammering AAPL share prices non-stop.


While overall analyst rating remains bullish, the number of hold and sell calls are rising fast for AAPL .

Source: TradingView

Bloomberg reports that META is expected to show revenue growth of 26% this quarter and almost double the net earnings from a year ago.


Analysts remain very bullish on META with an average 12-month price target of USD 540.90 a share.

Source: TradingView

MSFT is expected to benefit from AI. It has cleverly implemented Copilot AI into its product suite. Last quarter, demand for AI fuelled growth in its Azure cloud-services business.


Analysts remain constructively bullish on MSFT with 54 out of 57 analysts holding a Strong Buy or Buy rating on the stock.

Source: TradingView

NVDA will be the most watched quarterly earnings yet again. Its stock is priced to perfection. Feeble earnings or guidance could send its share prices into a free fall.


Fifty-three of Sixty analysts have either a Strong Buy or a Buy rating on NVDA with average 30% upside over next 12-months.

Source: TradingView

EV market contraction. Price wars from Chinese EV makers. Deep discounts. All these are heavily weighing down on TSLA shares.


Not unexpectedly, analysts remain neutral on TSLA .

Source: TradingView

ILLUSTRATING BETA HEDGING USING INDEX OPTIONS
Super Seven earnings are critical to US equities given their outsized impact due to substantial index weightings. Valuations remain lofty. Despite the recent selloff, these mega caps trade at an aggregate thirty-one times forward earnings.

Earnings can and does have enormous impact on share prices. When valuations are priced to perfection, even a hint of negative news will plummet stock prices down.

Astute portfolio managers defend their portfolio using beta hedging. Beta hedge requires that notional of the hedging trade is equivalent to the beta-adjusted notional value of single stocks.

Illustration of the beta hedge below assumes that a portfolio manager holds thirty shares in each of the Super Sevens.

TradingView publishes trailing twelve month beta values for each firm which is the stock’s sensitivity to the S&P 500 index.


In the lead up to results, implied volatility on shares expands rapidly. While hedging using equity put options is an alternative, but it is an expensive one.

A portfolio manager can cleverly deploy short-dated equity index options to minimise hedging costs. CME offers Micro E-Mini S&P 500 Options (“Micro S&P500 Options”) with each contract providing a notional coverage of USD 5 times the S&P 500 index which translates to USD 25,000 per lot based on current S&P 500 levels of 4,967.23.

Using Micro S&P500 put options expiring on 25th April 2024 at a strike of 4950, a portfolio manager incurs a premium of USD 105 per lot based on close of market prices on 19th April 2024. It requires approximately 4 lots (USD 25,000 per lot times 4 lots = USD 100,000) notional of put options to hedge the above beta adjusted portfolio of USD 107,153.

Source: CME

Table below illustrates hedging pay-off under different price action scenarios during quarterly earnings:


Long Options delivers financial convexity. Options allow portfolio managers to harvest asymmetric gains. It provides protection when markets plunge and allows portfolio managers to capture gains from rising markets.


MARKET DATA

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