Volatility Spread and the Stock Market Response to Earnings Announcements

43 Pages Posted: 18 Jan 2015 Last revised: 4 Apr 2017

See all articles by Qin Lei

Qin Lei

University of Michigan at Ann Arbor

Xuewu Wesley Wang

Quinnipiac University

Zhipeng Yan

New Jersey Institute of Technology

Date Written: February 4, 2016

Abstract

Using a broad sample of earnings announcements, we find that option call and put implied volatilities become increasingly misaligned as the earnings announcement dates (EAD) get closer. The percentage deviation between call and put implied volatilities increases monotonically in the one-month period leading up to the EAD. In addition, the direction of these deviations is consistent with the announcement returns of such earnings releases. More importantly, by adapting the earnings response coefficient (ERC) framework, we find that pre-earnings option trading actually increases rather than decreases the stock market response to the earnings announcements. In a cross section of earnings announcements, we find stronger stock market reaction from earnings announcements with greater abnormal implied volatility spread immediately before the EAD. By relating option volume to investor attention, we find higher pre-announcement option volume is associated with increased stock market response. Overall, our findings suggest that pre-earnings option trading helps alleviate the stock market under-reaction to earnings announcements and make the stock market response more complete.

Keywords: volatility spread, earnings response coefficient

Suggested Citation

Lei, Qin and Wang, Xuewu Wesley and Yan, Zhipeng, Volatility Spread and the Stock Market Response to Earnings Announcements (February 4, 2016). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2551260 or http://dx.doi.org/10.2139/ssrn.2551260

Qin Lei

University of Michigan at Ann Arbor ( email )

Ross School of Business
701 Tappan Street
Ann Arbor, MI 48109-1234
United States

HOME PAGE: http://leiq.bus.umich.edu

Xuewu Wesley Wang (Contact Author)

Quinnipiac University ( email )

275 Mt Carmel Ave
Hamden, CT 06518
United States
6179353977 (Phone)

Zhipeng Yan

New Jersey Institute of Technology ( email )

United States

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