Understanding Earnings Volatility
Earnings announcements can lead to significant price movements as the market digests new information. Prior to earnings, options prices typically rise as implied volatility (IV) increases - reflecting uncertainty around the outcome. Immediately after results are released, this IV often collapses in what traders call “volatility crush.”
This general pattern creates a framework:
● Before earnings: IV is elevated → options may become more expensive
● After earnings: IV collapses → options may become cheaper
● Stock reaction: the direction and magnitude of the move drive changes in option values, which may be gains or losses
Understanding where you are in this cycle is essential when evaluating a strategy.
Strategy 1: Long Straddle (Pre-Earnings)
What it is: A long straddle involves buying both a call and a put at the same strike price and expiration.
Why use it: This strategy is typically used by traders who want exposure to the possibility of a significant price move in either direction, without expressing a directional view.
This description is for information only and is not a suggestion to use the strategy.
Example:
If a stock trades at $100 before earnings, you could buy the $100 call and $100 put expiring shortly after the announcement.
Rationale:
● If the stock jumps to $115 → the call may gain value, put may expire worthless
● If the stock drops to $85 → the put may gain value, the call may expire worthless
The key is whether the stock’s move exceeds the total premium paid and how implied volatility behaves after the announcement.
Risk assessment:
● Maximum loss: the combined premiums
● Breakeven points: strike price ± total premium
● Main risk: the stock stays flat or implied volatility falls, and the value of both options decreases
Strategy 2: Covered Call (Post-Earnings)
What it is: A covered call involves owning shares of a stock and selling call options on those shares.
Why use it: This approach is typically used by traders who want to collect a premium on shares they already hold, while accepting that this limits the potential upside if the share price rises. After an earnings announcement, implied volatility (IV) may remain elevated for a short period before normalising, which can influence option premiums.
This description is for information only and is not a suggestion to use the strategy.
Example:
If you own 100 shares of a stock trading at $300 after its earnings announcement, you might choose to sell a $310 call option expiring in 2-4 weeks.
Rationale:
Residual volatility after the announcement may keep option premiums higher than usual. Selling a call allows you to collect a premium while still leaving some room for the stock to rise before reaching your strike if the price moves in that direction.
Risk assessment:
● Main risk: If the stock rises sharply, you give up some potential profit. Because you sold a call, you may have to sell your shares at the strike price, even if the market price moves much higher.
● Maximum profit: The income from the option premium plus any gain in the share price up to the strike. Anything above the strike belongs to the call buyer, not you.
This approach is typically used when a trader is comfortable with the possibility of assignment and accepts the upside limitation.
Key Considerations Before Trading Earnings
Implied Volatility Levels: Compare current IV to the stock’s historical IV ahead of previous earnings.
Expected Move: Use the at-the-money straddle price to gauge the market’s estimated post-earnings price range.
Historical Reactions: Check how the stock has typically reacted to beats, misses, and guidance over recent quarters.
Timing:
● Pre-earnings: IV may expand
● Post-earnings IV may decline or stabilise
Position Sizing: Because earnings are inherently unpredictable, be mindful of this when sizing positions and ensure you understand the full risk/reward profile and the potential for significant losses.
Conclusion
Earnings season - regardless of the time of year - can be associated with heightened volatility, which affects option pricing and risk. By understanding volatility patterns, reviewing strategy characteristics, and managing risk carefully, you can approach these periods with greater awareness of how options behave around major events.
With calls and puts tradeable on Investa, and covered calls on the way, traders and investors will soon be able to access a wide range of earnings-related strategies directly within our app.
Remember: options trading carries significant risks, especially around unpredictable events like earnings. Always conduct thorough research, understand the risks involved, and never trade more than you can afford to lose.