There's a simple way to outperform the market during earnings season, according to Goldman Sachs' options research team: Bet on the stocks that are making investors nervous ahead of their reports.
More specifically, the first step of the strategy is to find the companies that have underperformed the S&P 500 by 3 percent or more in the two weeks before their earnings (and also have liquid options). So far this quarter, that would have rounded up 15 stocks.
Then, traders are to go ahead and buy call options on this type of stock five days before earnings, picking options with a striking price just above the stock's current price. One then prays for an earnings jump, and selling the options the day after the report.
Goldman's options team, which does not actually recommend prayer, reports that had one pursued this strategy for third-quarter earnings, one would have seen a return of 30 percent. This compares to an average return of 18 percent for the strategy over the past 20 years. (Readers should note that both figures exclude transaction costs.)
The strategy may sound a bit wonky, but the premise behind it is clear.
"We have found that over the past 20 years, stocks that underperform have had a tendency to stage relief rallies on reported earnings," the team, led by Katherine Fogertey and John Marshall, wrote in a note released this week. "This bias in the market has made buying calls on these stocks particularly attractive."
Jake Weinig, founding partner of options-focused hedge fund Malachite Capital (and who, in full disclosure, previously ran a derivatives sales team at Goldman) says this strategy has worked because "we've been in a market where contrarian views have really paid off for a lot of traders."
Many of the stocks that have sunk into earnings have had "so much short interest," Weinig said Wednesday on CNBC's "Trading Nation." When these types of stocks report positive earnings, "traders can have some really nice returns by buying these very cheap calls."
Or, to put it in the form of a famous investment chestnut: "When everyone's crying, you should be buying."
Yet in this case, by buying calls instead of the stock itself, one is protected in case the company really provides something to cry about.