Anticipating Jumps: Decomposition of Straddle Price

Abstract

We develop a novel method to decompose a straddle into two assets: a volatility risk asset and a jump risk asset. Using the price ratio of the jump risk asset to the straddle, we create a forward-looking measure (S-jump) that captures the stock price jump risk anticipated by the option market. We show that S-jump substantially increases before earnings announcements and strongly predicts the size and the probability of earnings-induced stock price jumps. We also find that S-jump amplifies the earnings response coefficient. Our jump risk asset captures the run-up and run-down return patterns observed for straddles around earnings announcements.

Keywords: Jumps, Uncertainty, Straddle, Earnings announcements

JEL Classification: G12, G13