Understanding Stock Volatility On Earnings  

July 28, 2023

Diving into the world of stock trading and financial markets can be both exhilarating and daunting. Among the myriad strategies, one fascinating concept stands out: the implied move of a stock on earnings. But before we dive into options lets review the foundation of what options are 

Call and put options are two types of financial derivatives that provide the holder with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) within a specific period of time (expiration date).  

  • A call option gives the holder the right to buy the underlying asset at the strike price. 
  • A put option, on the other hand, gives the holder the right to sell the underlying asset at the strike price. 

Buying Call options are typically used by traders who expect the price of the underlying asset to rise, while buying put options are used by those who anticipate the price to decline. Both options provide opportunities for hedging, speculation, and risk management strategies in the financial markets.  

The most commonly used strategy to understand Implied earnings move is a complex option strategy called a straddle

Option straddles are investment strategies used in financial markets to profit from significant price movements in an underlying asset. In a straddle, an investor simultaneously purchases a call option (giving the right to buy) and a put option (giving the right to sell) with the same strike price and expiration date. This strategy is employed when the investor anticipates a substantial price fluctuation but is unsure about the direction; such as an earnings release.  

If the asset's price moves significantly upward, the call option generates profit, while the put option may expire worthless. Conversely, if the price moves downward, the put option generates profit, and the call option may expire unused. The goal is to profit from the substantial movement regardless of the direction.  

With the knowledge of options and the strategy that are used we can now look at how to calculate and understand implied move on earnings. The implied move on earnings refers to the estimated potential price range within which a stock is expected to move following an upcoming earnings announcement. It is derived from options’ pricing and represents the market's anticipation of volatility surrounding the earnings release. By analyzing the premiums of at-the-money call and put options, (the straddle we just learned about), traders can calculate the earnings implied move.  

For example, if the call option premium is $2.50 and the put option premium is $3.75, the implied move would be $6.25. This suggests that the market expects the stock move on earnings to be approximately $6.25 in either direction following the earnings announcement.  

 However, it's important to note that the implied move on earnings is an estimate and not a guaranteed prediction of the actual stock price movement. Actual market conditions, unexpected news, and other factors can influence the stock's behavior, leading to deviations from the anticipated range. Traders often use the implied move on earnings as a reference point for making informed decisions regarding options strategies or risk management surrounding earnings events.  

Source: https://www.theoptionsguide.com/long-straddle.aspx  
This post is for informational and educational purposes only.  It is not to be construed as investment advice, or a recommendation of any security, strategy, or account type.  Investors must be sure to understand all risks involved with any trading strategy, including commission costs, before placing any trade.   Inclusion of specific security names in this blog post does not constitute a recommendation from us to buy, sell, or hold.  
Further, this post is not an offer or solicitation for brokerage services, investment advisory services, or other products or services in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the securities laws or other local laws and regulations of that jurisdiction.  The provision of the services referred to in this material is subject to relevant local regulation and practice, and not all the services described may be available in your particular jurisdiction.  Any investment decisions made by an investor shall be based solely based on the investor's independent analysis taking into consideration their financial circumstances, investment objectives and risk tolerance.  Although the information has been produced from sources believed to be reliable, no warranty express or implied is made regarding its accuracy, adequacy, completeness, legality, reliability, or usefulness.

We are not affiliated with any third-parties or service providers mentioned in this post. Past performance of a security or strategy does not guarantee future results or success. 

Brokerage services are provided through Think Alpha Securities LLC, Member FINRA and SIPC.  116 Commons Way, Princeton, NJ 08540. Not insured by the Federal Deposit Insurance Corporation (FDIC).

Options Risk Disclosure:
Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount. Options trading subject to eligibility requirements.


Read More:

Tradingalpha.com is a website owned and operated by Think Alpha Securities LLC (doing business as “Tradingalpha”). Brokerage services are provided through Think Alpha Securities LLC, Member FINRA and SIPC. 116 Commons Way, Princeton, NJ 08540. Not insured by the Federal Deposit Insurance Corporation (FDIC). This material is sales and trading commentary and does not constitute investment research. This material is provided to you by Think Alpha Securities LLC (“TAS”) solely for informational purposes, is intended for your use only and does not constitute an offer or commitment, a solicitation of an offer or comment (except as noted for CFTC purposes), or any advice or recommendation, to enter into or conclude any transaction (whether on the indicative terms shown or otherwise), or to provide investment services in any state or country where such an offer or solicitation or provision would be illegal. TAS is not acting in any fiduciary capacity and it will not treat recipients as its customers by virtue of their receiving this material. The provision of the services referred to in this material is subject to relevant local regulation and practice, and not all the services described may be available in your particular jurisdiction. Brokerage services are provided through Think Alpha Securities LLC, Member FINRA and SIPC.  116 Commons Way, Princeton, NJ 08540. Not insured by the Federal Deposit Insurance Corporation (FDIC).
©2023 THINKalpha. All rights reserved.