Although we have been in a bit of an earnings drought, some of the recent results have not been encouraging. In recent days, FedEx (FDX), Nike (NKE), CarMax (KMX), and Micron (MU) all reported either disappointing earnings, reduced guidance, or both. Four companies hardly make a robust sample, but they are a disproportionate piece of the available data and represent a fairly wide swath of the economy (transportation, consumer, tech). Ready or not, we need to be thinking about how to position or hedge ourselves for what could be a rockier than normal set of results.<\/p>\n\n\n\n
Even though earnings releases and the market\u2019s subsequent reactions are difficult to predict, options traders utilize a predictable set of strategies to prepare themselves. One of the most basic tactics is to boost implied volatilities for the dates that encompass earnings releases. Compare these two implied volatility graphs for JPM and TSLA, noting the relative levels of implied volatilities for options expiring on the 14th<\/sup> and 21st<\/sup> of this month:<\/p>\n\n\n\n Source: Interactive Brokers<\/em><\/p>\n\n\n\n Source: Interactive Brokers<\/em><\/p>\n\n\n\n Note that JPM options expiring on the 14th<\/sup> have the highest implied volatility while those expiring on the 21st<\/sup> are highest for TSLA. (We use the following month\u2019s regular expiration as a control group for \u201cnormal\u201d volatility). <\/p>\n\n\n\n This should make perfect sense. We know that companies have a propensity for greater movement after they release earnings, and we can track how much a given stock has moved after prior reports. According to Bloomberg data, JPM\u2019s average post-earnings move is 2.04% and TSLA\u2019s is 7.35%. Market makers use that sort of data in their models, which tend to be reflected as a boost to the one-day volatility for the earnings date. <\/p>\n\n\n\n If we think of an expiration\u2019s implied volatility as the market\u2019s best estimate of the average daily moves that the stock will experience during that ensuing timeframe, the relative importance of a day with excess volatility will increase as that day approaches. That is why we see the earnings week\u2019s volatilities increasing faster than those of the non-earnings weeks. Bear in mind also that JPM\u2019s earnings also that JPM\u2019s report on the 14th<\/sup> will still affect the pricing for options expiring on the 21st<\/sup>, though in a less dominant manner, while TSLA\u2019s earnings should have no impact on options expiring 5 days prior (barring a pre-announcement).<\/p>\n\n\n\n There are 9 trading days after today until October 14th<\/sup>, 14 until the 21st<\/sup>, and 34 until November 18th<\/sup>. The effect of an extra day of volatility is much more muted by the following month, which is why the November volatilities seem relatively unaffected. <\/p>\n\n\n\n Here is what to keep in mind:<\/p>\n\n\n\n These factors introduce a key element of timing for speculators and hedgers. Even though implied volatilities tend to increase as earnings dates approach, the options may become less expensive in absolute dollar terms because options with higher implied volatilities tend to decay faster. Many speculators prefer to wait until the final day, hoping to avoid as much decay as possible, but they may face wider spreads and worse liquidity if fewer are willing to take the other side just before an event. Also, volatility assumptions may change dramatically based upon supply and demand and whether similar companies have beaten or missed their numbers.<\/p>\n\n\n\n Trading ahead of earnings can be as much art as science, especially in a quarter when results and outlooks may be in greater flux than normal. Hopefully an understanding of the factors that move implied volatilities ahead of earnings releases can move the needle a bit more in one\u2019s favor.<\/p>\n","protected":false},"excerpt":{"rendered":" Normal people might begin thinking about fall foliage, apple cider, pumpkins, and sweaters, but investors and options traders alike need to begin considering how this month\u2019s earnings season might affect their strategies.<\/p>\n","protected":false},"author":4,"featured_media":105177,"comment_status":"closed","ping_status":"open","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[14700,6,19,8,9,22,26,3],"tags":[267,2397,860],"contributors-categories":[13576],"class_list":["post-160032","post","type-post","status-publish","format-standard","has-post-thumbnail","category-ibkr-market-insights","category-north-america","category-options","category-region","category-securities","category-stocks","category-text-articles","category-traders-insight","tag-earnings","tag-earnings-season","tag-volatility","contributors-categories-interactive-brokers"],"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"\nJPM: Implied Volatility by Expiry, October 14th<\/sup> (green), October 21st<\/sup> (yellow), November 18th<\/sup> (orange)<\/em><\/strong><\/h3>\n\n\n\n
![\"JPM:](\"\/campus\/wp-content\/uploads\/sites\/2\/2022\/10\/Picture9.png\")
<\/figure>\n\n\n\nTSLA: Implied Volatility by Expiry, October 14th<\/sup> (blue), October 21st<\/sup> (yellow), November 18th<\/sup> (orange)<\/em><\/strong><\/h3>\n\n\n\n
![\"TSLA:](\"\/campus\/wp-content\/uploads\/sites\/2\/2022\/10\/Picture10.png\")
<\/figure>\n\n\n\n