What are some of the things that traders should be aware of when looking to trade earnings? For starters, IV expands before the announcement but not at the rate of Theta (time decay). IV collapses following the announcement. More can be found in the Market Measures segment from July 24th, 2015, “Earnings after the Announcement”.
IV does expand before an earnings announcement, but contrary to the claims of some, buying volatility going into earnings and then selling prior to the announcement is not a smart strategy. There are several Market Measures segments that examine this:
1) "Long Volatility Into Earnings" from July 7th, 2015.
2) "Long Straddles Into Earnings" from July 14th, 2015.
3) "Goldman Sachs: Earnings Straddles" from July 15th, 2015.
The market will price in an expected move for the stock going into earnings. The market will adjust the option prices to that expected move as the earnings date approaches. This leads to an artificial increase in IV due to the number of days to expiration (DTE) decreasing.
A graph of the volatility contraction after an earnings call was displayed. The graph showed that this makes short premium trades ideal. When doing so it is important to wait until the end of the day before selling premium. This is because the trade should be "centered" around the expected move.
Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the valuable takeaways and a better understanding of how volatility acts going into and coming out of an earnings announcement.
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