In our quest to understand trading options for income, we often consider holding positions through earnings announcements. In this article, we look at the risk associated with these events.
At the end of every quarter, public companies file their financial statements (a financial report card) which includes net income, net sales, earnings per share and earnings from continuing operations. This allows investors to gauge the performance and financial health of the company. In addition to the statements, companies also provide guidance reports: an estimate of future earnings for the next quarter. It typically includes revenue estimates, earnings, margins and capital spending.
Any earnings announcement surprises (good or bad) will likely result in big price movements exceeding 1 SD (standard deviation). As a result, we often refer to earnings announcements as binary events (there is either a big move, or not).
To determine the impact of earnings announcements, Tasty Trade recently conducted a test on AAPL, AMZN, BBRY, and CMG totaling 66 earnings cycles. The test included 2 cycles: one including earnings; the other after earnings. For both cycles, the Option Chain IV (implied volatility) with 30 DTE (days till expiration) was used to calculate the 1 SD expected move.
The test looked at the following metrics: the number of occurrences in which the price exceeded 1 SD during the 30 DTE period for both earnings and non-earnings; and the extent to which the price exceeded the expected move.
The results: cycles including earnings announcements exceeded the 1 SD expected move 39 percent of the time vs. 29 percent for cycles of non-earnings. The average percent of excess was 73 percent for earnings cycles vs. 44 percent for non-earnings cycles; and the percent max / min for excess was 253 / 2 percent for earnings cycle vs. 136 / 1 percent for non-earnings cycles.
In conclusion, there is greater risk (by 10 percent) of holding positions through an earnings announcement where price exceeds 1 SD. But more importantly, the max (or worst case) price movement for an earnings cycle was nearly two times greater than a non-earnings cycle.
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