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How ORATS Removes Earnings Effect from Implied Volatility

Posted by ORATS Team on 8/23/18 10:56 AM

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ORATS has a way to remove the effect of earnings announcements on implied volatility (IV).

Normalizing IV allows for a better way to study it historically and compare cross-sectionally. For example, in the days before an earnings announcement, IV can rise as much as 50% in the front month expirations. Much of this rise is due to traders expecting a large move after announcement. If observers are not able to remove this effect, the valuable information baked into IV may be lost.

Consider TSLA below where earnings were announced on 8/1 and after the gap between the IV with and without earnings narrowed in the graph below. This is why it is important to isolate just the ex-earnings IV if analyzing implied volatility over time.

To remove the implied earnings effect in the IV, ORATS follows these steps.

  • Make accurate implied volatility calculations by using accurate inputs like interest, dividends and residual rates;
  • Apply accurate earnings announcement dates to determine how many earnings apply to each expiration;
  • Solve for an implied earnings effect that makes the most rational resultant monthly implied volatility relationships;
  • Present monthly and constant maturity readings historically.

For example, consider LULU that announces earnings 8/30/2018 after the close. Presented below is the method for extracting earnings from IV. See the at-the-money IVs for each expiration, post removal of earnings effect IV, and that portion of the IV that is applicable to the earnings announcement move:

The 8/25/2018 expiry does not have an earnings effect. 8/31/2018 has the largest earnings effect (since the earnings effect will have a greater percentage of days relative to the number of days to expiration). Notice how the method solves for a remaining NEW IV skew that is still down sloping (backwardation).

The earnings effect is not the same as the percentage earnings move implied by the ATM IV relationships. In our Core Data API the percentage move implied from the options pricing for LULU is 10.93%.

impErnMv
10.93

Here are the last 12 actual earnings moves and the average absolute earnings move 11.698% to compare to the 10.93% Implied Earnings Move:

absAvgErnMv
11.698
ernMv1 ernMv2 ernMv3 ernMv4 ernMv5 ernMv6 ernMv7 ernMv8 ernMv9 ernMv10 ernMv11 ernMv12
16.316 9.211 6.4292 7.1937 11.5472 -23.4389 15.0401 -10.5531 -0.1327 -13.1327 -16.4091 10.972
ORATS Team

Written by ORATS Team

ORATS is a premier options analytics vendor committed to uncovering untapped alpha-generating solutions. ORATS utilizes an advanced, proprietary volatility analysis to produce implied, forecast, and historical volatilities that have been proven to be more accurate market summarizations than those obtained from most commonly available sources.

Topics: Markets

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