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Volatility Crush & Earnings

By:Dr. Jim Schultz

Position yourself to sell when volatility is at its peak and then take advantage of the impending volatility crush

  • Every three months, like clockwork, public companies must release earnings reports to let shareholders know how they are doing.
  • Once these reports are released to the public, volatility is almost always “crushed” as the uncertainty of the event itself is no longer there.
  • Therefore, premium sellers can take advantage of this phenomenon by using short option strategies right before earnings are released.

One of the most reliable events in the market is the quarterly earnings announcement that every publicly traded company reports every three months.

Heavily concentrated in January, April, July and October, every publicly traded company is required to let shareholders know every quarter how the company is performing. These events always have the potential to move the market in significant ways.

Because of this oversized likelihood of a big move, traders often bid up option prices on both sides of the market (calls and puts) before the report—something that leads to higher and higher implied volatility in the options themselves.

The inevitable crush

Once the report is released—and whether the stock goes up, down, or nowhere—the mystery associated with the event dissipates. So, it should come as no surprise that once the numbers are out and the market digests the news, the uncertainty surrounding that event disappears, and hence, the volatility in the option prices vanishes, too.

In fact, this phenomenon is so reliable that, whenever you hear traders refer to a “volatility crush," you can be certain that they are referring to the drop in volatility in option prices surrounding an earnings report or some other big event, such as a consumer price index (CPI) release or Federal Open Market Committee (FOMC) announcement. All the volatility that was created by the event quickly dissipates once the event comes and goes.

Using short options

As premium sellers, we can benefit from this sequence of events, as any factor that sends option prices lower will be helpful to our position. And since option prices and volatility move together, volatility falling means that option prices will fall, too—a benefit to any option seller looking to buy back their options at lower and lower price.

Whether the stock is Apple (AAPL), International Business Machines (IBM), or Tesla (TSLA), we at tastylive, we love putting on short premium strategies mere minutes before the earnings reports are released to the public.

This way we position ourselves to sell when volatility is at its peak and then take advantage of the impending volatility crush.

Jim Schultz, a quantitative expert and finance Ph.D., has been trading the markets for nearly two decades. He hosts From Theory to Practice, Monday-Friday on tastylive, where he explains theoretical trading concepts and provides a practical application of those concepts to a trading portfolio. @jschultzf3

For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.

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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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