Although the holiday season is approaching, one of the most important seasons for traders is already well underway - earnings season!
Public companies are mandated to release their earnings on a quarterly basis, and these announcements (or the approach of them) often produce dynamic movement in implied volatility and underlying stock prices.
For volatility traders, this can be a paradise, because there are so many opportunities to deploy attractive mean reversion bets, or even directional plays.
One stock that already produced some exciting headlines in the current earnings was International Business Machines Corporation (IBM). After its earnings release in mid-October, the stock dropped roughly 7.5%, and now sits close to 3-year lows.
For traders that played that event correctly, they are no doubt patting themselves on the back in the aftermath - that can be the type of move dreams are made of.
While earnings season can be a boatload of fun, traders also need to remain disciplined by deploying positions that match their risk profile. That may mean avoiding single-stocks altogether, especially from the short premium side. Or, at least using "defined risk" structures in favor of positions with theoretically unlimited risk.
Another choice for traders is to utilize market indices and/or ETFs. If you are looking for more information on trading stock indices during earnings, a new episode of Market Measures is undoubtedly worth a few moments of your time.
New research compiled by tastytrade is presented on the show that provides further perspective on how a stock index such as SPY typically behaves during earnings season - in terms of movement in both implied volatility and realized volatility.
In order to produce the necessary results for this analysis, the Market Measures team designed a study that utilized historical data to reveal how implied and realized volatility differed (if at all) during earnings in a given year, as compared to the non-earnings periods on the calendar.
As you can see in the graphic below, this data is certainly eye-opening - although maybe not for the reasons you might have originally believed:
As you can see in the table above, both implied and realized volatility remained relatively constant whether it was earnings season or whether it was not. In fact, the overstatement in implied volatility (market cost of volatility) versus realized volatility (what actually came to pass) was about the same no matter the time of year.
Depending on your strategic approach this may help you optimize your trading approach going forward.
Traders that prefer long premium during earnings, especially in single-stocks, may view this data as solid evidence that short index premium could be one method of balancing their overall exposure (i.e. long single-stock premium for earnings versus short index premium).
Likewise, this data may also provide traders with added confidence to maintain a short index premium strategy throughout the year. It all depends on your own unique trading approach and risk profile.
No matter your take on the data, you can always mock trade (i.e. paper trade) a new trading idea prior to deploying it "live." Mock trading allows us to gain important experience and perspective on a new trading style or position without the risk of capital losses.
If you have any questions about trading indices during earnings, we hope you’ll leave a message in the space below, or contact us directly at @tastytrade on Twitter or at firstname.lastname@example.org at your convenience.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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