Tuesday, July 24, 2007

Earnings Spike Potential Algorithm v1.1

First there was the VWSI, now it seems like I am going to try to get ESPA (Earnings Spike Potential Algorithm) off the ground. This immediately raises the question: just how many ugly acronyms should I try to prop up in this space? Maybe I should just do it the way the rest of the world does and start with the acronym I want, then reverse engineer the full text.

Never one to leave well enough alone, I have taken my CNBC Million Dollar Portfolio Challenge (remember that disaster?) cardboard and duct tape version of the ESPA and tweaked it a little for the current earnings season. The changes are not that major and consist largely of beefing up some TA inputs having to do with support and resistance. The resulting ESPA v1.1 seems to do a better job of predicting the magnitude of the post-earnings move and a noticeably better job of picking the direction of that move (which was previously just a little above 50%.)

Armed with a better mousetrap, I will be more active in earnings plays this quarter than usual, using the model to be both long and short straddles and strangles, as well as playing some instances where I have directional bias with straight calls/puts or call/put backspreads.

I do not intend to clutter up with space with a flood of predictions or comments on individual stocks, though I may highlight one or two from time to time. Still, looking at some of the earnings spiker candidates for AMC today through BMO tomorrow, I was struck by the sheer number of stocks with a very high short squeeze potential and a high implied volatility, two ingredients that can help turn a couple of sparks into a widespread conflagration.

Stepping back a little, my thinking is that most of the recent market action has been of the healthy correction variety – the controlled burn that renews instead of destroys. I also think that much of the bearish sentiment we find rolled into an 18ish VIX is of the bullish contrarian variety. As far as I can tell, the big fears are on the table and in the headlines. I suspect that it will require something new and unanticipated to give us the type of conflagration where we could see something like the VIX of 25-30 referenced by Jim Kingsland.


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