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The Illusion of Volatility Into Earnings

| Apr 22, 2016

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Options Jive

The Illusion of Volatility Into Earnings

Apr 22, 2016

You’ve heard the claim that you can make money by buying options a few days ahead of earnings and then selling them just before the earnings release. This is supposedly profitable due to the increase in implied volatility (IV) that is caused by this binary event. Would you be surprised to learn that it’s all an illusion?

Implied volatility does increase in the days before an earnings release. A table displayed figures for FB, AAPL and JPM which showed a consistent increase in IV. Is the rise a reflection of an increase in the price of the option or of something else?

Our research team conducted a study in FB, AAPL and JPM. We examined the at-the-money (ATM) option prices, a Straddle, on the 4 days leading up to their earnings report and tracked the option prices relative to the stock price on each day. A table of the results of the 4 days leading up to earnings was displayed. The table showed that although implied volatility was rising in each stock into earnings, the Straddle price as a percentage of the stock price was decreasing.

Implied Volatility will increase for one of two reasons. The first, and what the strategy of buying options a few days before earnings is contingent upon, is an increase in option prices. Unfortunately (for those trying this strategy), the second possibility seems to be the cause of the rise in IV and that is that the option prices decay less than what theta projects.

Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the valuable takeaways and a better understanding of why IV increases as a binary event such as earnings approaches.

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