Hedging Goldman's Earnings Report

With the investment banks prominent role in the current financial and economic distress much attention will be given to Goldman’s earning report that could set the tone for the entire market this is week.

Investment and now commercial bank Goldman Sachs Group Inc. (GS) (67.74) will report earnings before the opening on Tuesday December 16, 2008. Taking our cue from Jamie Dimon at JP Morgan Chase & Co. (JPM), who said they are expecting a "terrible" fourth quarter, we wonder about the GS estimates for a loss of 3.50 per share. In the event the actual losses are larger than expected and the market takes the stock price lower here is a suggestion to hedge the downside for those long the stock or to take a short position for those who think the earnings estimates are not realistic. With a current Historical Volatility of 126 and an Implied Volatility Index Mean of 97.49 with a long-term forecast of 75, consider this suggestion.

• Buy GS Dec 70 put GSXN 5.875 IV 114.88 Delta -.5426

• Sell GS Dec 60 put GSXL 2.285 IV 140.39 Delta .2452

Debit 3.59 Position net delta -.2974

The debit indicated above is based upon Friday’s middle closing prices between the bid and ask. Considering time decay, the debit today should be about 3.56 if the stock price remains unchanged. Use the position net delta shown above to adjust for any stock price change or about .30 for each point change in the stock price. Comparing the implied volatility of the long put at IV 114.88 to the short put at IV 140.39 this spread has a good edge. Since the earnings report will be announced before the opening on Tuesday, there is just one day to open the position.

In the event the stock trades lower the maximum value of the spread is limited to the difference between the strike prices or 10 points. Subtracting the initial debit the maximum gain could be 6.44 or 181% in the event of a large stock price decline. The maximum loss is limited and defined by the debit while the volatility and time decay risks are mostly offset by the spread.

This is a December spread and the options will expire at the end of the week so we suggest the position be closed shortly after the earnings report is released or at least by the close on Friday. If the earnings are better than expected and the stock trades higher we suggest setting a SU (stop/unwind) in the event the stock trades above 75 before the expiration close on Friday.

Disclosure: no positions

Comments

[Yo Bob:]

>>will report earnings before the opening on Tuesday January 16, 2008<<

I presume that you mean DECEMBER 16, 2008.

2008 Dec 15 07:43 AM

[Shira Jacobson:]

Thanks, Yo Bob. It's been corrected.
Regards,
Shira Jacobson
Seeking Alpha Editorial Team

2008 Dec 15 07:51 AM

[Jack Walker:]

Yo Bob,

Thanks for the comment. The good folks at Seeking Alpha have made the correction. Yes, it is tomorrow December 16, 2008.

Jack

2008 Dec 15 01:15 PM

[Schweizer:]

Losses exceed revenue for the quarter? Wow.

2008 Dec 16 06:27 AM

[No entiendo:]

$2.12 Billion in losses, $4.97/share...greater than estimates...and the stock rallies???

2008 Dec 16 10:08 AM