ALL ROADS LEAD TO GOLDMAN / BARRON´S

Monday, July 13, 2009

THE STRIKING PRICE DAILY

All Roads Lead to Goldman


By STEVEN M. SEARS

The premiere bank's report will provide fodder for bulls and bears.

FEW FIRMS RIVAL Goldman Sachs ' (ticker: GS) prowess trading derivatives, currencies, fixed income, commodities and stocks.

This makes the bank's Tuesday morning release of fiscal-second-quarter earnings a must-read for investors eager to check their performance against a firm that dominates the global markets as the Roman Empire once ruled the world.

In the options market, investors are surprisingly cautious toward Goldman, putting them at odds with the recent rash of bullish analyst and media reports that suggest the bank will report a phenomenal quarter.

"Say you buy Goldman stock because you think it will be a blowout quarter but you have no idea about the next earnings report," says a derivatives trading strategist at a major investment bank, summing up the difficulties bulls face in the financial sector. "If you're right, Goldman trades up on earnings after which you may just want to get out since you have no idea about what to expect next. If you're wrong and they disappoint, the stock trades down and, again, you have no idea what to expect next."

The difficulty anticipating Goldman's near-term future results are reflected in Goldman's August 150 calls that are bid at a rather plump $7.10.

Investors who own Goldman stock, and are worried about the bank's earnings power beyond the fiscal second quarter, can consider selling August 150 calls against a portion of their stock. The trade makes sense for investors with a cautious near-term view, and who do not mind selling the stock at about $157.

"Goldman's options might be a better sale than a buy," said Michael Schwartz, Oppenheimer & Co.'s chief options strategist.

Of course, uber bulls who would rather not wager against Goldman and its ensuing symphony of bullishness can simply buy calls to position for an advance in the stock.

Goldman's options prices suggest the stock will move 5.7%, up or down, when the company reports earnings.

With the stock up almost $4 at about $145 Monday, the most widely held options include Goldman's July 150 and 155 call. A deeper review of trading patterns since the start of July, which is about the time traders would start making earnings trades, reveals caution among sophisticated traders.

According to data from Options Clearing Corp., which issues and settles all options, orders classified as "firm" -- often proprietary trading desks at investment banks or other institutional traders -- are more active in Goldman's puts than calls. For every 100 calls traded by firms, 127 puts have traded. This suggests the market's most sophisticated investors are slightly cautious.

Orders classified as "customer," which includes institutional investors and individual investors, show 94 puts traded for every 100 calls since the start of July. This is slightly bullish, but "customer" trading volumes are typically considered "uninformed order flow." Institutional traders often like to sell when customers buy, and buy when they sell.

Options traders are not alone in disagreeing about Goldman's earnings. Among analysts following Goldman, earnings-per-share estimates range from $2.82 to $4.27, though the mean estimate is $3.21.

The fact that there is broad disagreement among analysts who mostly follow identical earnings models indicates vastly different assumptions about the performance of various business units. One analyst, for example, might expect trading revenue to increase 15%, for example, compared with 5% for another.

The story in Goldman is reflected in the Select Sector Financial SPDR (XLF) that is widely used by traders and investors to express views about financial stocks. XLF put and call volume has been extremely active since last week , reinforcing the battle underway in financial stocks.

One way or the other, Goldman's earnings report will offer something for bulls and bears. The report will provide crucial data to investors wondering if the stock market's massive advance that began in March is an extraordinary bear-market rally or the beginning of the end of the worst financial crisis since the Great Depression.

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