Market Volatility During Earnings Seasons
By:Kai Zeng
We are at the end of an earnings season when all of the surprises have been to the upside. The latest company to report an unexpected profit was Target (TGT). Almost no one has fallen short of anticipated performance.
But the question arises of whether upside or downside surprises in earnings a overall market volatility? Regardless of whether earnings miss or hit expectations, it's challenging to predict the resulting market and volatility movements.
We have examined different earnings cycles over several years to determine if earnings themselves impact the indices. Our findings indicate that it's almost random. Some earnings cycles may send the market slightly lower or higher, but most don't significantly impact the market. It's impossible to predict these movements, despite what some may claim.
Like other earnings seasons, the third quarter provided attractive trading opportunities for premium sellers. This is due to a significant drop in implied volatility in individual stocks after earnings announcements.
We analyzed the implied volatility of individual stocks and found that on average, it decreases by roughly 45% after earnings. This is why the earnings move projected based on option prices is usually inside the actual earnings move.
We also analyzed the S&P 500 (SPX) short-term implied volatility (IV) during various test periods. The results showed that compared to stocks, the implied volatility of the index moves randomly during the earnings season. On average, the Chicago Board Options Exchange's CBOE Volatility Index (VIX) experiences a decrease of only 1.5%, much less significant than individual stocks.
There is a noticeable trend in individual stocks implied volatility; it remains at a relatively low level after a significant decline following earnings. However, this trend does not apply to the implied volatility of the SPX.
We examined the correlations between the short-term VIX and the volatilities of specific stocks, including International Business Machines (IBM), Goldman Sachs (GS), Walmart (WMT), Amazon (AMZN) and Apple (AAPL). The results showed a more positive correlation between the implied volatility of individual stocks and the short-term VIX in the most recent quarter. However, there isn't enough evidence to suggest a strong correlation exists between them over the long term.
In conclusion, the implied volatility of individual stocks decreases significantly and tends to maintain at a low level for an extended period of time after earnings announcements. However, this does not necessarily apply to the index implied volatility. During earnings season, the correlation between individual stocks and the implied volatility appears to be more random.
Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
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