Lesson Overview

Buying Ahead of Earnings Expansion

If we know that we can profit from higher implied volatility levels heading into an earnings announcement then a rational question would be, "Can you take advantage of expanding volatility heading into earnings?"

In this video tutorial we'll give you multiple examples of why you may not be able to buy options ahead of earnings implied volatility expansion and why focusing all of our attention on the IV crush that happens the day after earnings is a much better use of our capital and time.

More Discussion

Was This Helpful? Add Comments/Questions

  • Did you catch the typo on the first slide? It was a late night and I clearly didn’t read over it but you all get the gist!

  • Got it updated and thanks for letting me know Kevin – sometimes I just import the wrong video into the player. PLEASE let me know if you find any others! Thanks!

  • Just tells us the IV rank percentage and the recent stock move.

  • Depends on a whole host of things really but either are fine as long as you can get outside the expected move.

  • But the main question is this: how do you know this time it WILL have an increase? Our backtesting shows this is less than reliable to guess and assume some will vs others won’t.

    • Lance Ehrhardt

      Ok, thanks Kirk

  • It’s all about current IV – if it’s high and likely to drop then trade it – if not, skip.

Show Video Transcript +

In this video tutorial, I want to talk about a common question that we get here and that’s, “If we know that implied volatility is high around earnings, then can we buy options heading into earnings and profit consistently?”

It’s this whole idea of buying options into earnings and I totally get the question because we talk about it so much and you probably hear other guys talk about it out there about this idea of implied volatility dropping or seeing this IV crush after earnings.

But if the idea and the philosophy is that implied volatility is high around when an earnings event happens, then it's logical to think that at some point we could buy options heading into earnings and potentially profit.

We’ve had some guys on our podcast talking about how they do it with their strategy and how they back-test different strategies, so we decided what we’re going to do here is go through a couple of examples.

We’re going to look at some examples of big-name stocks and how their implied volatility has moved heading into and after earnings and then we’ll let you guys decide and throw our opinion in here as well.

Let’s start off. We’re going to look at the first one which is BBBY and probably one of my most favorite ones to trade around earnings because it really is the poster child for a huge drop in implied volatility after the earnings event.

Down on the bottom of the screen, this is a chart that tracks implied volatility of the stock that we’re looking at. This green line is going to track whether implied volatility is high or low and you can see how quickly it drops or doesn't.

You can see that every single time that BBBY which is Bed Bath & Beyond has earnings, it has a huge drop in its implied volatility the day after.

And probably one of the more consistent stocks out there, we just traded it profitably through this earnings cycle that we’re in, but you can visually see that this stock does in fact have a huge rally up heading into earnings and then a big important crush down.

It is pretty consistent in this case that we do get the rally up heading into earnings and we also get the crush moving down. When we look at another example, this is Google, Google is another example of a stock that has a pretty good history of seeing that implied volatility crush as well.

We go back over the last year, we can see Google's got a number of times where the stock has run-up heading into earnings and have that crush down. Although there are a couple of times where it did have a crush down in volatility, namely this one right here, we did not see the run-up in the stock’s implied volatility heading into earnings.

The previous couple of earnings session, we saw a big run-up heading into the earnings season, we just didn't get that, in fact, the stock actually traded more or less sideways heading into earnings, but we did see the implied volatility crush afterwards.

And then the same thing here, it did have a pretty nice run-up heading into earnings, big IV crush, but what we’re seeing right now is Google trade sideways and flat heading into earnings, we’re not seeing that expansion that it usually have.

What’s important to note about this particular stock is that although sometimes we do see a run-up in implied volatility, what’s more reliable in this case is that IV crush that we do see.

Let’s look at another one here. Let’s look at LinkedIn. LinkedIn is unique with Google in the fact that over time, it does see that big implied volatility crush heading into earnings.

All of these earnings seasons and any announcements that we saw, implied volatility definitely dropped after that, so that was really reliable. And in some cases, not all cases, implied volatility more or less rallied heading into earnings.

In the case here back in April and May, you can see it actually peaked out in May and then actually came down heading into earnings. Same thing here, it actually peaked out in July and then headed down into earnings. Same thing in October, it peaked out and early October, it headed down into November for earnings.

We maybe expect the same thing to happen here as we get towards February, is that it peak’s out sometime soon and then starts to slowly consolidate as we get closer and closer to that event. But you can see the more consistent and reliable way to trade this was the actual drop in implied volatility.

Alright, we’ve looked at a couple of great examples of huge drops in implied volatility. Now here are some big names that don't quite have the big, big, big drops in implied volatility.

They have good drops in implied volatility, no doubt about it, a pretty good drop, but you can see all of these examples here with Facebook which is a pretty big-name, pretty liquid security had implied volatility that peeked way before their earnings event and in some cases was actually much lower than the previous couple of events.

You can see here in July, implied volatility was much, much lower than it was in February and March of the same year, so implied volatility overall was low. Even though it had a slight rally, it was overall low.

Same thing here, it peaked way early and implied volatility was actually much lower heading into the earnings event. In this case, you probably couldn’t have taken advantage of buying implied volatility heading into that event.

As we look at some other ones like Goldman Sachs, Goldman Sachs is a great example here because it has just one instance where implied volatility was super high heading into earnings and that was here in October of last year.

Every other time as you got closer to that earnings event, you really didn't see that jump in implied volatility, nor did you really see too much of a drop afterwards. You did see a drop, but it wasn't as pronounced to some of the other things that we’re looking at.

Same thing here in April when it announced earnings, we really didn't see that huge run-up in implied volatility, a slight incline and then we got that drop right afterwards.

It’s really interesting to see once you go back through and visually back-test a lot of these different stocks how the earnings actually work out. Same thing with JP Morgan…

This is the last one we’ll look at here before we finish up. But you can see that in most cases, JP Morgan earlier this year actually traded sideways in volatility before earnings, traded pretty much sideways in volatility before earnings.

This was the only time in October that we actually saw a move up in implied volatility and we did get that crush afterwards. It’s pretty interesting. We did see a move up in implied volatility.

Who knows if we see that crush tomorrow when they announce earnings? But it’ll be interesting to see what the result is. Alright, as you can see, there’s no right or wrong answer, but in my opinion, I think the more reliable and consistent trade is to sell options around earnings and profit from the IV drop.

There's no hard fast evidence that shows that buying options into earnings is definitely profitable, but I know like I said that we’ve interviewed traders and we know traders that have done that, you just have to do a lot more work and back-testing to do it.

I personally believe and the way that I continue to trade is that the more reliable and consistent trade is that drop in implied volatility which even though it might not be as big in some stocks, it’s actually still there and still relevant, you still get that drop in implied volatility even if the stock didn’t have a huge run-up in IV heading into earnings.

Hopefully this answers the question for you and helps you make a decision on which side of the trade you want to be on. As always, if you have any comments or questions, please add them right below the video lesson here. Until next time, happy trading!

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