← InstitutionalLesson 14 · 4:02
Pricing an event: earnings, FOMC and CPI against base volatility
Summary
You can turn two expiries either side of an event into total variance, take the step between them and read the move the options price for that one day. You can compare it with the stock's own past event moves measured the same way, decide cheap or rich, and size for the surprise.
Key terms
- total variance
- Volatility squared times the days covered, drawn as a block as wide as the days and as tall as the volatility squared.
- event step
- The jump in total variance that one event day adds above the straight ramp of normal days.
- priced move
- The size of move the options imply for an event, the square root of that event day's variance.
- rich
- When an option or event is priced for a bigger move than the yardstick, measured the same way, suggests.
- cheap
- When an option or event is priced for a smaller move than the yardstick, measured the same way, suggests.
- FOMC
- The Federal Reserve committee that sets US interest rates, whose scheduled announcements are market events.
- CPI
- The monthly US inflation report, a scheduled announcement that can move markets.
Check yourself
Answer each question to see why the right answer is right.
1. XYZ reports in 10 days. Its 7-day options price 30% and its 14-day options 43%. What explains the jump?
2. The 7-day expiry sits at 17 in total variance. Carried out to 14 days, normal days alone come to 35, but the 14-day expiry is at 71. What move do the options price for the report?
3. Eight made-up past report days, squared, averaged and square-rooted, give a typical move of about 4%. The options price about 6%. Why measure the past that way rather than a plain average?
4. You sell the 14-day $100 straddle at about 60% volatility for $557 a contract the day before the report, and close it the day after at 30%. Seven of the eight past moves would have won. What happened on the largest one, nearly 7%?
5. Made-up index ABC's 3-day options price 15% and its 8-day options, past a scheduled announcement such as the FOMC or CPI, price 17%. The priced move is a little over 1%, but past announcement days moved more, measured the same way. What do you conclude?
Finished the video and the quiz? .