The Analyst #2 - Brace for Impact
Each month, we’ll tell the story of an analyst’s journey to become one of the greats.
Like the rest of the Sternies from NYU, Jake loved to meet his buddies for poker on the third Wednesday of every month. They drank some beers, smoked a few cigars, and talked a healthy amount of shit about each other, their bosses, or simply aired their grievances du jour. But each year, October’s Wednesday was often a smaller group. And this year, it fell on the 16th. Maybe not the absolute busiest reporting day for companies, but damn near it. And just about everyone he went to school with four years ago was on the street now in some fashion, with many as analysts at the “usual suspect” funds. Peak earnings days were pressure filled and long. Still, he needed to see some familiar faces, whether they were faces that were ridiculously, overtly judgmental or not caring enough to judge him at all. He needed a beer with the boys. Besides, he only had two prints in his space this week, which he figured he could handle.
The gang usually rented the back of a bar somewhere on the Lower East Side to set up three tables and bring in food and drinks while they played hold’em. One or two of the guys considered themselves “real” card players, having entered a few small tournaments at Connecticut casinos and cashed out with a touch more than their $100 buy-in, but the rest were unqualified idiots that were just better at math than most people. Yes, it felt good to relax, let the guard down and just be…
“Jake, you ugly SOB!” His roommate was there, pointing at him with a group of friends as he walked in. They all back slapped, shared the standard “yo, what’s up?” and grabbed a seat.
“I’m just here to enjoy some delicious Bud Light and take a little money from people I actually know, as opposed to you clowns going up to Mohegan to bilk random strangers”. The game was light stakes, of course. It didn’t matter if they were playing for pennies – this was about bragging rights. The blind was $1/$2.
“How’s life working out for the big man?” His roommate Eric liked to call anybody’s boss ‘the big man’. It was an ironic twist on Wall Street, where every known fund had a larger-than-life personality type and no shortage of wannabes. Jake’s boss ran a $750 million industrial book, big enough to be called the big man, for sure.
“Good, good. Just one print where we’re involved in Alaska.” He meant Alaska Airlines, or ALK, typically considered one of the better carriers, whose stock had outpaced the market over the last three months by close to 10%, a nice alpha move.
His friends always looked at him a little cross-eyed when it came to airlines, a group whose volatility had ensnarled many would-be investors with volatility that could only be described as, well, turbulent. “Better brace for impact, my guy. I think they’re going to have to crush consensus to hold the current price”. Anil also worked for an industrials PM that traded the group at another firm.
“I hear you, bro. Spent a few minutes after close talking about the revenue bogey with my PM.”
Jake was talking about the set-up. This and other words, like positioning, narrative, consensus, and expectations, were used somewhat interchangeably to convey the key debate the market would need to resolve. This would likely happen on the print, plus a day or two. It was the basic kind of arbitrage most long/short hedge funds played during earnings. For airlines in particular - nobody’s ‘usual suspect’ for long-term growth stories, but a good bell-weather of consumer sentiment for travel, and in this case, discretionary leisure travel – getting the print right was a big alpha opportunity.
Trading the group was never easy, especially since more of the ‘revenue soup’ for airlines was consumer driven, as business travel became less of a thing post-pandemic. But at ALK, profitability from the corporate business had come all the way back, or so the bull thesis went. And the Hawaiian Air deal was also seen very constructively - there would be synergies. Jake was focused on how much good news was already in the stock?
Anil pushed back a bit. He was the couch surfing buddy that had lived with him for part of his London semester-abroad, and now he was living rent-free in Jake's head. “I just don’t know what they can say to drive the stock higher. It’s had a great run since August.”
“The deal synergy numbers are going to be strong”. Jake had done the math (they all did the math) and the street was low.
“Ok, but if you were management, why provide any kind of better guidance update now? They’re going to under-promise now so they can over-deliver later. Wouldn’t you?” Rent-free of not, the guy made some sense.
Like the poker game he was sitting at with pocket 9’s in his hand, there were multiple decisions he could make. Eric, a decent card player, that raised the base bet of $2 to $4 when the second card flipped was a king. Maybe he was bluffing, but the utility of his 9s was decidedly less if he or anyone else was holding a king. He would probably need another 9 to flip. And giving the roomie four bucks was going to make Eric’s night for sure. “Call, Jake?”
“Fold” he said, as the usual trash talk flowed around him. His head was all in on ALK now. He had similar optionality in both poker and the print. He could raise his position size, call (stay where he was), or fold (sell it)... but he had one more option here than in his game: he could flip short.
For the best of them in long/short, the flip is a thing of beauty. It’s a way to make alpha both long and short on the same name. It makes sense from a trading perspective to go short sometimes because stocks tend to move in a jigsaw pattern, as opposed to just up or just down. In fact, this kind of vol is sought because monetization will often be a relatively short-term bet, like for the two days following the print in this case. And he loved the feeling of making money to make money on the short side. Like somehow, he’s ‘got one’ on everybody else.
Alright, he thought, bringing himself back. Settle the hell down. Make it about the math. The options market usually helped here. In the money calls were pricing in daily stock price volatility of about 3%, which was not much for airlines. But the skew to the print suggested the ‘day of’ vol was closer to 10%. That was a useful statistic in his mind in one respect: he agreed with Anil that to get another 10% upside move on top of what had happened already (lots of good news), seemed unlikely. Further, the hurricane impacts were disruptive to travel, and even though ALK routes were predominantly West coast, it could trade off with the group.
It was big boy time. He wanted to be short. Positioning was not crowded (short interest was not high). Hitting or even exceeding consensus was likely. So if good news was baked in, he would probably see a normal sell-off, perhaps 5%. And if the bar was not cleared, it could be more.
He scripted the next morning’s call to his PM as the game went on. He would recommend that they flip short, but at half the position size. His PM usually sized shorts smaller, as most experienced traders do, but he would recommend coming even a little less, a 2% position. These were the nimble trading plays he wanted to learn from, but he had no interest in any kind of big negative lessons. He would play small, and if he got paid, it would be great to add a little alpha. And if he was wrong, he’d cover and preserve some of the trading gains from the long. This was the normal daily life for long/short players. Ok, brace for impact.