Speaking of news, a common headline in web news strings for clients is: “Preparing for (fillintheblank’s) Earnings Announcement with an Option Straddle.”

Seen that? Traders wait for companies to say when they’ll report results. They prefer if you do it a few weeks ahead so they can get cheap puts and calls. Just days between your announcement and earnings, and options may be in high demand and limited supply. It’s a lesson, IR professionals, about modern markets.

But before we get to that, let’s talk about these traders tall in the straddle. A straddle means what you think: on both sides of the fence. Traders buy both a put, a right to sell shares, and a call, or the option to buy them. Each such contract represents 100 shares.

Used to be, you didn’t want options near the expiration date. The closer you are to an event, the easier to predict outcomes, and therefore the less the profit opportunity. Three months out, who knows if a stock will be $10 or $15? Five days, it’s easier to tell.

This fact is reflected in the market value of the option. If you buy a right three months out and as expiration approaches it’s apparent that your option is not likely to have value, you can’t unload it on somebody else for even what you paid. That’s time decay.

The hedge against something being worth less tomorrow is a straddle. Let’s make up a simple example. You trade at $10. You send a release saying you’ll report results in three weeks on Nov 18, ahead of expirations on Nov 19. A trader buys a call, the right to buy your stock, for $9. It costs the dollar difference between market and strike prices plus some time value set by the market. Say $1.

Each contract is 100 rights, so the trader pays $200. The trader also buys the opposite right, a put, also for $2, for the right to sell shares at $11. The trader spent $400, the total at risk.

Anytime, things can change the value of the straddle. Say your peer reports great results ahead of you. The call now is more valuable, the put weaker. Maybe the trader chooses to sell the call at a profit and let the put lapse.

The ways derivatives are used affects your liquidity and trading. If the underwriter of the call – say, a bank – is now at risk, the bank may buy shares in anticipation of needing to meet demand, and they may short your stock too, anticipating a drop based on call or swap demand fueling a brief speculative frenzy.

This stuff abounds today. And with high-speed trading in many asset classes and a colossal swaps business reflecting the same thing but in private contracts between parties, the combinations are nearly infinite. While you need not worry about controlling it, you can take steps to help that finite group of fundamental investors tuned to intrinsic value.

Lessons: When possible, avoid giving derivatives speculators a cheap path to profits. If you report after expirations, the time-decay component of an option’s cost will be greater, and the short-term profit opportunity smaller. What’s it hurt to wait three days?

By extension, if you know your results are likely to be spot-on with estimates, you may WANT to report before expirations. The chance to profit from derivatives speculation will be diminished because the expected result may be factored into your share price.

Heck, in a perfect world you’d vary your reporting dates to keep traders guessing – the opposite of the old convention about doing the same thing at the same time. But see, that conventional wisdom springs from when rational money was 50% or more of daily volume, ten years ago. Today it’s about 10%.

Looking cool in the IR chair ain’t what it used to be – but it’s just as cool as ever to be cool.

The SEC last week sued Goldman Sachs for misleading investors about certain collateralized debt obligations during the subprime mortgage meltdown. We’re not a news rag so we won’t regurgitate the facts and accusations. We’d observe, as did a fine Wall Street Journal blog at Deal Journal yesterday, that the investors supposedly mislead were the world’s most sophisticated CDO investors, that Goldman lost money, and that the disclosures about these swaps that always require two parties with opposing expectations of outcomes were of monolithic proportion. Up to and including acts of God, everybody party to them knew the outcome could be good, bad or ugly.

Which leads to trading last week. Options expired April 15-16 when markets gyrated. Markets were up a hundred points the day before, April 14, then down a hundred points. Today, April 20, volatility futures expired, and short-term trades between stock and index options last week and volatility moves today could pay with little time decay or risk for the savvy trader. There was actually more fundamental buying on April 14, the up day, than fundamental selling on April 16, the down day, data indicated. It’s not always about the news. There is no better proof than what happens under the skin of the market with monthly expirations.

So what’s it mean? Market structure tells us that money thinks the Goldman accusation is hooey.  And speculators were taking advantage of disruption in the markets around expirations. It’s been a fantastic run in the markets since expirations in March when we told you that risk hedges were perhaps the largest we’ve seen. Traders bet big on equity gains from March 19 to April 16, and the move paid off. And the dip on April 16 had little to do with Goldman Sachs.

We promised examples about using market-structure analytics, so we’ll leave you with one. Before its analyst day recently, a large public company wanted to set expectations. We could see reticence on the part of active money to pay up for shares. Speculators were working hard to foster intraday trading ranges, which meant that investors had uncertain views (speculators often know). Thus, meeting expectations alone would be positive, despite high expectations this spring for outperformance.

The stock rose a dollar the following day. Real or Memorex? Often, traders create momentum around analyst days – not difficult in this age of anonymity and electronic trading. But data showed that real money indeed paid $0.75 cents more. Price held up even during the recent market pullback.

It’s darned cool in the IR chair not having to guess if your trading activity is real or noise. As is using that information to make management wonder how in the world you know the stuff you know.

You might have had the same thoughts. Well, let’s clear up some confusion. Investor relations is not dead, and real money matters. For example, we see a regular spread between what we call the “rational price” and how programs and speculators trade stocks. When active money buys with slight vigor, we often see a 10% trading premium develop as traders rush toward the action. When the premium shrinks, price has peaked. Traders can’t entice followers.

Likewise, a dab of real money can reset price on the downside. Most times, changes in trends – trading markets are obsessed with trends – come from value money buying and causing a cascading reaction through the whole trading food chain. We see it on 50,000 shares in issues with daily volumes over 30 million. A stock that’s been sliding for several days reverses course.

A little real money goes a long way. It’s more important than ever. We write about the great magnitude of speculative and risk-management activity not to discourage you but hopefully to help you understand modern markets. If 75% of your volume is speculative at the same time your rational price is converging with the trading premium (as we saw for a biotech client today), shares are rotating and your stock has topped out for now. But if real money doesn’t sell, the pullback likely will be brief.

You don’t have to brood over terms or computer screens either. A few minutes a day or a little time each week is enough to keep a good handle on what’s under the skin of price and volume.

It’s great protection when the CFO ambushes you in the hall on a down day and asks you who spooked your stock. You can calmly reply that trading and investing are not the same thing. If there’s a problem, you’ll know from your market structure. Otherwise, traders are like clouds of colorful fish in tropical waters that sway and flash and flit in kaleidoscopes. Neat to see, you don’t want to miss it. But when you know, you won’t confuse them with the Orca lurking in the depths either.

I also believe the investor relations profession can shape policy. We in the issuer constituency have always been on the sidelines waiting for the banks and the traders and the exchanges to determine the nature of our capital markets. Who says we have to do that? IR can define the voice of public companies in policy. That’s not for everybody, I know. But it’s possible and within reach.

Wrapping up, what’s money doing as we leave options expirations behind us again? Money was more leveraged than ever in March – we see it in equity trades that ripple with expirations. We mean that most money in the markets this past month seemed to sport some sort of optimizer or multiplier. We’re being realistic, not pessimistic. Capital markets remain cobbled tenuously by some curious synthetic weave. It’s not dangerous yet. But it’s the Orca under the surface, and it’s closer. The markets are like the dollar: a promise that lacks substance.

Thankfully, we can count on the core IR audience, real money, to ride to the rescue whenever that fateful time comes. You’ll know by your market structure.

Your first thought is that it beats the alternative. Next is how it would be nice to know what the heck’s behind it.

One answer is equity swaps. Options expirations stretch across the balance of this week again, with volatility expiries tomorrow and stock and index (and currency, treasury, interest-rate instruments too) options and futures expirations Thursday and Friday. We think traders sometimes miss the importance of expirations by looking at the wrong data. It’s not in puts or calls so much as program equity trades, we believe. Data lead us to conclude that adjustments to derivative instruments in which investors offload various consequences and obligations associated with actually owning stuff has a big bearing. These are swap instruments.

Equity swaps could take any form but here’s an example. Say you’re running a total return portfolio that seeks to outperform the S&P 500. You could try to achieve it by picking stocks, but since 90% of managers don’t beat the market, the odds are against you. You could use managed futures, a popular way to follow a trend and add yield. But you’ve got futures trading issues, then.

So instead you call Deutsche Bank and arrange an equity swap. You agree to pay the bank a fee of some number of basis points over LIBOR (London Interbank Offered Rate) to receive the return on the S&P 500 Index via set monthly payments. That means capital gains and income distributions too. If the return is negative, Deutsche Bank is paying you, and if not, you’ve got a low-cost hassle-free way to produce your returns. Then with the money you’re saving on trading commissions, you do some short-term leveraged options to get a little yield. Presto, bingo, you’re delivering the goods (you hope).

But Deutsche Bank may adjust its assets and positions. If it’s got exposure, maybe it trades inversely correlated securities to reduce costs and limit risk. Especially around expirations. These rebalances can have a bigger impact on stock prices than puts, calls or portfolio events. Add in sophisticated proprietary trading systems that try to find these hidden rebalances and capitalize on divergences and you have a recipe for head-scratching performance.

Or in other words, the answer to why your stock goes up on light volume. It may be that a counterparty must pick up shares to change its exposure profile, and your stock, as you wrap up another annual-report cycle, is the unexpected winner on light but purposeful algorithmic buying.

Deutsche Bank is an illustration only. But these sorts of things are common. Risk-management activity can impact your price regardless of what business you’re in or what you’re communicating to shareholders in that letter.

And admit it, knowing is rather cool.

Speaking of derivatives, the dollar retreated today, and US equities rebounded. We all want it to be about investing. Commentary everywhere today polished bullishness to an economic sheen. But that won’t make it reflect reality. Money keeps buying short-term love because the direction of the dollar is like a blacksmith’s bellows on equities.

Tomorrow starts three days of expirations. We saw speculative trading spike last week, while European money returned on Feb 10. Traders had already discounted Greece’s woes and had gone searching for alpha. There are too many reasons for traders to pursue global statistical arbitrage (and regulators keep giving them more). Translating, that means it’s fun trading similar instruments in opposing fashion in different places to profit on spreads and timing, and not much fun investing in stuff.

What changes that? Funny you ask. We want to hate banks. We’d like it all to be Goldman Sachs’s fault that our economy is bloated on derivatives. Those blasted Wall Streeters and their nefarious schemes, like borrowing money at 15 basis points from the Fed, then using it to buy Treasuries paying 350 points of interest. Taking TARP cash and trading with it. Manufacturing reserves and using them to float atmospheric notional value swaps for obscene fees.

All that may be true. But banks don’t set interest rates on Fed money. Banks don’t decide, “Hey, let’s go con the Fed out of some cash.” Banks don’t determine the size of the money supply. Banks don’t write reserve rules. No, while we’re all tarring and feathering sellside CEOs, the folks spraying gasoline on everything and playing toss-the-match can be found at the Federal Reserve.

If we don’t want our stock markets to behave like roulette wheels, we must stop playing with Federal Reserve house money, which is cheap and artificial – or shall we say, derivative. Primary dealers from Barclays to BofA march as the Fed orders. Don’t think those folks who OK’d 100-cents-on-the-dollar payouts to AIG counterparties are aw-shucks hayseeds who got jobbed. They knew what they were doing. We should be asking why, rather than railing at the foot soldiers. We may not like the answer, but it’ll be true.

Speaking of money, I personally put cursor to Excel workbook and tallied 2009 earnings before non-cash items and taxes for seven of the primary dealers – the eighteen big US, European and Japanese banks commissioned by the Federal Reserve to make orderly markets in dollar-denominated US obligations – and came up with $185 billion. With a ‘b.”

From whence came these profits? Who deployed cash in the capital markets? It wasn’t institutions and individuals. The US government deployed about $3 trillion. Lord only knows how much came from other global central banks.

Lesson of the day: Governments create money. Goldman Sachs is not responsible for it. Banks work with what they’re given. If they get a gigantic mountain of cash, you can bet they’ll work with it.

If we want more investing and less trading, we might dump all that snow on the east coast atop the Federal Reserve and put the fire out. Unless Whistler offers a better deal.

If you wondered why your trading seemed odd that day, there’s a good chance it had to do with inscrutable black-box risk metrics run by major sellside firms helping the buyside modulate macroeconomic risk.

Oh, for the days when buyers and sellers set prices.

Volatility contracts expire tomorrow, Dec 16, and the usual index, treasury, currency, bond and other futures and options contracts cease Thursday and Friday the 17th-18th. Also, Christmas week, the S&P 500 futures, the SPL/SPX contracts, convert, and a new SPL series is added.

What do these mean to the IR job, and how do they work? SPLs and SPXs are options to buy or sell the S&P 500 index at future dates. They can be used as an asset for margin, as protection against risk, for trading volatility, for synthetically adjusting portfolios to mimic the S&P 500 without buying the actual elements – all kinds of things. How the market behaves around these expirations is like seeing the attitude of money rather than hearing the words it speaks.

Here’s the key: contrary to prevailing notions, derivatives are not an evil tool of wicked free markets. Derivatives are always an effort to deal with price and risk uncertainty. The more widely they’re deployed, the greater the risks and uncertainties. Risks and uncertainties are greatest in speculative markets and highly regulated markets. In both instances, the role of value in setting prices is obscured.

IROs and execs, these features matter. Imagine going up the down escalator. This is the nature of the capital markets at present. Too many factors are interfering with natural price-setting mechanisms. In order to explain what seems inexplicable about your share price at times, it’s necessary to understand how the value of money and the effects of risk-management work in equity markets.

We continue to say that the single largest problem now is Federal Reserve policy. Central bankers believe that the supply of money, which represents an exchange of value, can increase, even if there is no exchange of value. On corporate balance sheets, these conditions would result in a reduction to retained earnings, a dilution to equity, a writedown of asset values, or a journalizing entry affecting net worth in some way.

But that doesn’t happen in Federal Reserve policy. Inevitably, a bubble forms someplace.