Traders were blindsided by Celgene's massive earnings flop
- Celgene turned in a brutal third-quarter earnings report, missing revenue forecasts and cutting its long-term profit outlook.
- Traders were woefully unhedged by several measures, leaving them vulnerable to feel the brunt of the stock's 20% drop.
Traders weren't prepared at all for the huge stock drop that befell Celgene after a disastrous third-quarter earnings report.
The drug developer saw shares plummet as much as 20% after quarterly revenue fell short of analyst estimates and the company lowered its long-term profit forecast for 2020, yet investors entered the reporting period woefully unhedged.
Investors were paying the lowest premium in almost three years to protect against a 10% decline in Celgene's stock over the next three months, relative to bets on a 10% increase, according to data compiled by Bloomberg. When the measure - known as skew - is low, it implies either directional bullishness or a simple lack of downside protection.
It was an even starker situation for traders placing hedges against a deeper drop. Skew for 20% downside hedges over a three-month period, relative to wagers on a 20% spike, was the lowest since December 2007 heading into Celgene's earnings.
One would think traders would've been more wary heading into the quarterly report, considering the company was less than one week removed from announcing that they'd failed a late-stage trial in a highly anticipated Crohn's disease drug. That news caused an 11% single-day drop in the stock, which has plunged 30% since the start of September.
One possible explanation is that investors thought that weakness meant the stock was at low risk of slipping further, and they pared hedges accordingly.
That they were so wrong provides a cautionary tale for traders heading into earnings season. No matter how downtrodden a stock may appear, all it takes is a devastating report to make matters even worse.
