Too Good to Be True? An Analysis of the Options Market's Reactions to Earnings Releases
Forthcoming, Journal of Business Finance & Accounting
32 Pages Posted: 24 Jan 2011 Last revised: 29 Jul 2016
Date Written: January 22, 2016
Using option implied risk neutral return distributions before and after earnings announcements, we study the option market's reaction to extreme events over earnings announcements. While earnings announcements generally reduce short term uncertainty about the stock price, very good news does not reduce uncertainty and slightly bad news actually increases uncertainty. Cross-sectional tests of realized volatility reductions are largely in line with option implied findings, except for cases where very good news is released, which suggests an irrational level of perceived uncertainty in options markets following very good news. We also find that left tail probabilities decrease over earnings releases while right tail probabilities increase. We interpret these findings as evidence of maintained investor expectations that very good news is generally not released during earnings announcements combined with unwarranted skepticism at the release of such news.
Keywords: Earnings Announcements, Option Implied Distributions, Tail Risk
JEL Classification: G14, G17, G24
Suggested Citation: Suggested Citation