Earnings Volatility Plays

M

maninjapan

Guys, I am currently looking into some different possible earnings plays, specifically in regards to volatility in the weeks leading up to earnings. I am working on 2 assumptions/ hypothesis (both of which may prove to be false or not profitable) One is that the total IV of an underlying often has a tendency to increase leading up to the earnings announcement, the other is that the front month IV will increase at a greater rate than a back month creating an increasing spread in IV.

I am a little confused as to which strategy woud best take advantage of this situation. Calendar? Reverse Calendar, or other? My understanding of a Calendar is that it generally results in a profit with an increase in volatility (all other greeks being equal for now). However I would think that if you wanted to profit from the increase in IV spread between the front month and the back month, then a reverse calendar would be the strategy to use.
If anyone has any input on this it would be much appreciated.

Thanks in advance
 
Quote from maninjapan:

Guys, I am currently looking into some different possible earnings plays, specifically in regards to volatility in the weeks leading up to earnings. I am working on 2 assumptions/ hypothesis (both of which may prove to be false or not profitable) One is that the total IV of an underlying often has a tendency to increase leading up to the earnings announcement, the other is that the front month IV will increase at a greater rate than a back month creating an increasing spread in IV.

I am a little confused as to which strategy woud best take advantage of this situation. Calendar? Reverse Calendar, or other? My understanding of a Calendar is that it generally results in a profit with an increase in volatility (all other greeks being equal for now). However I would think that if you wanted to profit from the increase in IV spread between the front month and the back month, then a reverse calendar would be the strategy to use.
If anyone has any input on this it would be much appreciated.

Thanks in advance
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You really need to look at the Vegas of the different months back month vegas are much higher than front.

So even if the fronts IV increase more than the backs IV you can still lose money because of the difference in vegas.

IV is not money you need to look at your Vegas for that.

A calendar play works well with rising volatility as you are long the Back month which has a greater vega.

Reverse calendars are a way to play falling vol environments.
 
you might want to read some of Jeff Augen's books. he's a bit cavalier about selling premium, but he has good matierial on earnings cycle plays. your thinking is sound: long vega into earnings and/or short vega afterwards.

be careful about the IV skew across the calendar. long back IV/short front IV plays are deceptive in that the vega is dominated by the back month. you can sell from month vol at 100% and buy back month vol at 65% and think you've got a great position on, only to get destroyed after earnings when all vols get crushed.
 
yeah, thats what I would expect in a regular environment, but when you have a situation like earnings (where I am assuming that front IV can get up a lot higher than the back IV) and you ratioed the spreads, could you expect to profit from it with a reverse calendar?
 
Quote from maninjapan:

I am working on 2 assumptions/ hypothesis (both of which may prove to be false or not profitable) One is that the total IV of an underlying often has a tendency to increase leading up to the earnings announcement, the other is that the front month IV will increase at a greater rate than a back month creating an increasing spread in IV.
More...
Your assumptions are correct. What you do with them is the tricky part.

I am a little confused as to which strategy woud best take advantage of this situation. Calendar? Reverse Calendar, or other? My understanding of a Calendar is that it generally results in a profit with an increase in volatility (all other greeks being equal for now). However I would think that if you wanted to profit from the increase in IV spread between the front month and the back month, then a reverse calendar would be the strategy to use.
More...
I don't think that there's an easy cookie cutter answer. What strategy works best depends on a number of variables ... amount of skew, amount of IV inflation, time remaining, as well as your ability to either guess the direction or set something up that does reasonably well regardless of the direction. Of paramount importance is your ability to guesstimate the post EA IV (or be wrong yet the stock goes there) as well as being able to adjust on the fly in the pre/post market or regular hours.
 
Lots of discussion on Earnings volatility topic in older threads. Using the search button may answer your assumptions/hypothesis before they are even fully formulated. Search for posts by IV_Trader, dmo, list goes on. I don't recall if Maverick74 or riskarb did earnings related plays, but their old options posts are insightful nonetheless.
 
Quote from maninjapan:

I am a little confused as to which strategy woud best take advantage of this situation. Calendar? Reverse Calendar, or other? My understanding of a Calendar is that it generally results in a profit with an increase in volatility (all other greeks being equal for now). However I would think that if you wanted to profit from the increase in IV spread between the front month and the back month, then a reverse calendar would be the strategy to use.
More...
A single reverse calendar is problematic because you also have to get the direction right otherwise premium capture from IV contraction can be lost by a large move away from strike. To offset this, you can do double reverse calendars and tailor the risk graph to your liking. As mentioned by Kedwards, there's been a lot of discussion here on many things and a search will turn it up. For an interesting earnings play with ratioed double calendars, search for bebpasco's posts.
 
Quote from hsmc1970:

You really need to look at the Vegas of the different months back month vegas are much higher than front.

So even if the fronts IV increase more than the backs IV you can still lose money because of the difference in vegas.

IV is not money you need to look at your Vegas for that.

A calendar play works well with rising volatility as you are long the Back month which has a greater vega.

Reverse calendars are a way to play falling vol environments.
More...

hsmc, do you know which book of his specifically covers earnings plays? He seems to havea few there.
 
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