← IntermediateLesson 5 · 3:47
How do earnings change option prices?
Summary
You can explain why implied volatility climbs before a known earnings date and crushes right after it. You can read the move the price already expects from the at-the-money call and put together, and see why being right about direction can still lose money when the move is smaller than the one you paid for.
Key terms
- earnings
- A company's announcement of how much money it made.
- volatility crush
- The sudden fall in implied volatility right after news such as earnings, because the big unknown is gone.
- expected move
- A rough guide to the size of move an option price assumes, read from the at-the-money call and put added together.
- implied volatility
- The swing size an option's price assumes; an estimate, not a promise.
- break-even
- The stock price on the last day where you neither make nor lose money: strike plus premium for a call, strike minus premium for a put.
Check yourself
Answer each question to see why the right answer is right.
1. The day before earnings you buy the $100 call for $3.55 a share ($355). Next morning XYZ is up $2, and the tag falls from 60% to 30%. Where are you?
2. What is the volatility crush?
3. Nothing has happened yet, but XYZ's tag climbs from 40% to 60% as earnings get closer. Why?
4. The day before the news, the $100 call costs $3.55 and the $100 put costs $3.54. Roughly how big a move does the price expect?
5. The next morning, with the tag at 30%, roughly where does XYZ need to be for your $3.55 call to be ahead?
Finished the video and the quiz? .