Anticipating Uncertainty: Straddles Around Earnings Announcements

Abstract

Straddles on individual stocks generally earn significantly negative returns. However, average at the money straddles from three days before an earnings announcement to the announcement date yield a highly significant 3.34% return. The positive returns on straddles indicate that investors under-estimate the magnitude of uncertainty around earnings announcements. We find positive straddle returns are more pronounced for smaller firms, firms with higher volatility, higher kurtosis, more volatile past earnings surprises and less trading volume/higher transaction costs. This suggests that when firm signals are noisy, and/or when it is costlier to trade, investors underestimate the uncertainty associated with earnings announcements.

Keywords: Uncertainty, Volatility, Straddle, Earnings Announcement

JEL Classification: G02, G11, G13