Anticipating Earnings Reverals: The Mosaic Company; CF Industries Holdings

There’s a belief among equity spread traders that earnings can act as a catalyst for mean reversion.  This makes intuitive sense since there can be a big runup into earnings on one side of the spread, and an earnings miss could spook investors, or an earnings beat can get sold into.  Both situations can potentially lead to mean reversion.

The situation you don’t want to find yourself in is relying  on earnings catalysts when you’re on the wrong wide of the trade for a prolonged period and looking for salvation.  An upcoming earnings date can be the last hail mary pass before a trader finally gives up on a position.  You do not want to make a habit out of relying on earnings to bail you out.

When you have a relationship with long-term statistical correlation and co-integration, earnings events are less of a factor.  A good example of this is the $MOS$CF spread.  For the last two years we have seen several examples of the earnings reversal catalyst, but it’s more likely that this is reflective of the ebb and flow of  money from one stock to the other relative to the discounted value of their future cash flows.  I let the earnings pass, wait for the smoke to clear, and and follow my signals before committing to a full-sized position.  No need to game earnings.

$MOS earnings dates are highlighted in GREEN and $CF is in BLUEClick image to enlarge.

I’m currently looking at this from the perspective of long $MOS and short $CF.  This is a pure statistical trade as there is no real clear fundamental edge for one or the other.  As of today, $CF earnings have pushed the relationship to a statistical condition that occurs less than 5% of the time.  Not a bad edge if you believe that the last earnings cycle has not irreparably damaged the statistical relationship that exists between these two stocks.

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