Options Corner: Traders Are Signaling For Caution Ahead Of Newmont's Earnings Report

Newmont Corp (NYSE:NEM) has easily ranked among the top players in the market recently, thanks largely to the blistering rally in the underlying gold market. Given the excitement over precious metals — which stems from several catalysts, including central bank acquisitions and rising industry demand — it's understandable that some analysts are incredibly bullish on the long-term prospects of gold miners. Still, it's important to note that two things can be true at the same time.

Obviously, there's no doubting the mercurial ascent of gold. In terms of NEM stock, the security is up almost 21% on a year-to-date basis. Further, anticipation is palpable for Newmont's upcoming Feb. 19 earnings report, where analysts expect the mining giant to deliver earnings per share of $1.91 on revenue of $6.01 billion for the fourth quarter. These figures would represent a sizable boost from the year-ago quarter's print of $1.40 and $5.65 billion, respectively.

However, it's also possible that much of the optimism has already been priced into NEM stock. As such, the next earnings report would likely have to deliver a remarkable performance for investors collectively to move the needle. While such an outcome cannot be ruled out, it's a highly risky wager. Not only that, the smart money appears somewhat skeptical of this thought process.

Primarily, volatility skew provides an important clue about high-level sentiment. This screener identifies implied volatility (IV) — or a security's potential kinetic output — across the strike price spectrum of a given options chain. For the Feb. 20 expiration date (the day after earnings), the hedging activity appears to prioritize downside insurance.

In particular, the skew shows elevated put IV pricing relative to calls at the lower strike price boundaries, reflecting that downside movements represent a non-trivial risk. As such, the smart money seeks protection for that possibility. On the upper strike boundaries, call IV is relatively muted in relation to put IV, which suggests that the hope of extracting upside profitability is not a priority.

In my opinion, that's information by omission. With gold fever in full pitch on the retail side, you would expect that if the smart money felt the same way, a pronounced spike in the skew would materialize.

It hasn't materialized — and I think you need to note this discrepancy.

Establishing the Trading Parameters of NEM Stock

While we now have a basic understanding of smart money sentiments, we're still at a loss as to how this may translate into actual price outcomes. For that, we may turn to the Black-Scholes-derived expected move calculator. Wall Street's standard mechanism for pricing options anticipates that Newmont stock will land between $110.79 and $130.46 for the Feb. 20 expiration date.

Where does this dispersion come from? Black-Scholes assumes a world where stock market returns are lognormally distributed. Under this framework, the above range represents where NEM stock may symmetrically fall one standard deviation away from spot (while accounting for volatility and days to expiration).

What Black-Scholes is saying is that in 68% of cases, Newmont stock would be expected to trade within the prescribed range 10 days from now. Honestly, it's a reasonable assumption, if only for the fact that it would take an extraordinary catalyst to drive a security beyond one standard deviation. That said, we still don't have enough information to make a clear directional debit-based trade.

Essentially, we have reached the limits of first-order analyses, which primarily center on observational screeners and tools. Following the above analysis, we understand what the smart money may be thinking and how that thought process may translate into possible outcomes. However, we still don't know what the probable outcome is.

To find that answer, we must graduate from first-order analysis to second order; that is, move from superficial observation to conditioned observation.

What we have here is the search-and-rescue (SAR) conundrum. NEM stock is effectively a shipwrecked survivor. Black-Scholes has identified a distress signal that went out somewhere in the middle of the Pacific Ocean. By the time our team gets to the point where the signal went out, the survivor has drifted.

With the expected move, we have a search radius — and that is genuinely valuable information. Unfortunately, we live in a world of limited resources so we can't dedicate a full-on search to find this one survivor. To maximize our resource expenditure, we need to use probabilistic math to find the likely drift pattern (conditional signal), not just a list of all possible paths (observational signal).

This is where the Markov property comes into view.

Narrowing the Probability Space for Newmont Stock

Under Markov, the future state of a system depends entirely on the present state. Colloquially, forward probabilities should not be calculated independently but be assessed in context. When looking at the SAR analogy, different ocean currents — such as giant, powerful waves versus relatively still waters — can easily influence where a shipwrecked survivor is likely to drift.

Here's how the Markov property relates to NEM stock. In the last 10 weeks, NEM stock printed a staggering nine up weeks, leading to an overall upward slope. There's nothing special about this 9-1-U sequence, per se. However, this quantitative signal represents a specific type of ocean current. Subsequently, an entity caught in these waters would drift in a particular manner — and one that is likely to be different from drift patterns associated with other current types.

From here, we're just going to engage in pattern recognition. Through enumerative induction, we will observe how prior 9-1-U signals responded and apply that information to the current spot price to estimate forward outcomes. We’ll also use Bayesian-inspired inference to provide a more realistic estimate given that we're dealing with incredibly small sample sizes.

Assuming that you believe in the premise above, we can calculate that NEM stock is likely to range between $109 and $123 over the next 10 weeks, with probability density peaking near $116. Because earnings reports tend to accelerate kinesis, it's possible that we can see these prices materialize following the disclosure. Please note that our conditioned range falls mostly inside the Black-Scholes-derived dispersion.

Given this market intelligence, I'm tempted by the 117/115 bear put spread expiring Feb. 20. This trade requires NEM stock to fall through the $115 strike at expiration, which is an ambitious target. If the price level is triggered, the maximum payout would be almost 113%. Breakeven would land at $116.06, which is practically on the head of expected peak probability density.

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