Earnings Announcements and Option Returns
43 Pages Posted: 16 Dec 2016
Date Written: April 2016
While prior studies find that returns on option straddles are generally negative, we show that returns on straddles purchased prior to earnings announcements are actually positive. The earnings announcement impact is compounded when the pre-portfolio formation volatility is low (high) and the pre-expiration realized volatility is high (low). Apparently, the average option trader underestimates future volatility before forthcoming earnings announcements, particularly after a period of relatively low volatility, and overestimates future volatility after recent earnings announcements, particularly after a period of relatively high volatility. The overestimation of future volatility after recent earnings announcements also increases with the magnitude of the earnings surprise.
Keywords: Earnings Announcement; Option Pricing; Stock Return Volatility
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