The Magnificent Seven Earnings Next Week Might Not Live Up to Expectations, but It is a Smart Hedge

Next week promises to be a pivotal moment for investors as the "Super Bowl" of earnings season unfolds. Most of the “Magnificent Seven” (Mag 7) companies, which are central to the AI revolution, will deliver their eagerly awaited fourth-quarter earnings reports.

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These tech giants played a major role in driving the S&P 500 to 57 record highs in 2024. This week, the index set yet another all-time high, underscoring the dominance of these companies.

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Over the decade that ended in December 2023, the top 10 largest stocks in the S&P 500 saw their market capitalization share nearly double, rising from 14% to 27%. By January 2025, the Mag 7 stocks alone now account for a staggering 34% of the index's total weighting, highlighting their growing dominance in shaping market performance.

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Adding fuel to the tech rally is President Donald Trump, who has moved swiftly in his second term to introduce a slew of executive orders and policies that favor the tech sector. Chief among these initiatives is the newly announced Stargate AI project—a massive $500 billion program that has become a focal point for tech investors.

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Despite the Mag 7’s impressive gains and their dominance of the market, there are reasons to exercise caution. One key concern lies in the substantial capital expenditures (CapEx) these companies are undertaking, with uncertain timelines for return on investment (ROI).

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For instance, Mark Zuckerberg recently announced that Meta Platforms (META) plans to spend significantly more on CapEx than initially estimated—raising its projection to $60 billion to $65 billion, well above the $40 billion expectation. While this announcement pushed META stock to new all-time highs, it underscores the broader “spend more, make more” mindset that currently dominates the tech sector.

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The real question is whether these investments will deliver meaningful returns, a concern that will likely come into sharper focus later in 2025.

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The Hedging Strategy

To protect profits amid potential volatility in the Mag 7 stocks, one approach is to hedge using the Vanguard Growth Index Fund ETF (VUG), which holds many of the same tech-heavy stocks.

Here’s the trade:

• Sell the VUG $440 call expiring 2/21/2025 for $2.50
• Buy the VUG $415 put expiring 2/21/2025 for $3.25

This trade, known as a risk reversal, was executed for a slight debit of $0.75 per spread (or $75 in total). At the time of execution, VUG was trading around $426.75.

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Trade Details

Both the call and the put are approximately 3% out of the money. By selling the call, the investor generates premium income that helps offset the cost of buying the put. This strategy allows the investor to hedge downside risk while limiting upside participation.

• For investors with Mag 7 exposure: Writing the VUG call caps potential gains but provides a hedge in case of a market pullback.
• For those without Mag 7 exposure: Consider buying an additional out-of-the-money VUG call to define the risk in this trade, ensuring a more balanced spread.

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Hedging serves as a prudent strategy when future market returns for the tech sector may already be priced in. The sheer scale of CapEx spending by the Mag 7 companies, coupled with the uncertainty around ROI, adds a layer of risk that investors cannot ignore. While these companies have fueled record highs for the S&P 500, their lofty valuations leave little room for error.

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By using a risk reversal on the VUG ETF, investors can effectively position themselves to mitigate potential downside risks in a concentrated tech portfolio. At the same time, this strategy enables participation in further upside—albeit to a limited extent—if the tech rally continues.

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The Mag 7 companies have been instrumental in shaping the market's direction, but their future performance depends heavily on the success of ambitious investments like Meta's spending plans and initiatives such as the Stargate AI project. While optimism remains high, a cautious approach is warranted given the potential for volatility and uncertain ROI timelines.

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Hedging with instruments like VUG provides a practical way to navigate these risks while maintaining exposure to the broader market. As earnings season unfolds, this measured strategy could prove invaluable for investors looking to balance opportunity and risk in a tech-dominated market.

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