the volatility of the jumps
Jump Vol before Earnings
- Thread starter TheBigShort
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the volatility of the jumps
Robert Morse
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I have no idea. I have never been overly analytical. I try to keep trading very simple, maybe because the math is over my head. When I did trade earning, I had to have a process for estimating IVOL for each month for the 1st 30 min of the day, then the rest of the day-after the event was over and uncertainty was off the table. Without going into too much detail, I would base that not on past changes but on the trading of options 6 months out that typically do not move much for an "event". I would use that to determine what I expect options are worth the next day. Then I would determine how much the stock would have to move the next morning to breakeven on the ATM straddle or the calendar I'm looking at. To me, that is the implied move the options are inferring. If I expect that is too high or too low, then I would look to do some option strategy that would provide the best risk/reward for the current market prices vs what I expect. The only unknown to me was the stock price movement. I made markets in up to 12 options and followed another 5 to 10. I knew them well and how they acted.
I'm sure there are better ways to do this, but this worked well for me. In general, earning plays are very difficult and directional plays without some edge seem very random to me. In fact, I find that if you told me the earning the day before, I often still can't guess at the direction or size of the move as it often comes from the other items the company says like expected sales of the following quarter. Guessing the direction of the move is 40/60 at my skill level.
You can imply event vol from the options implied vol, it's a matter of simple algebra. Two possible cases:
Assumptions: two types of days in the world, event day E and ambient day A (all vols below are daily, so first convert implieds by dividing by 16).
Case 1: You have an option that expires before the event (with vol1 and days to expiry days1) and after (vol2 and days to expiry days2). You get a system of equations
vol1*vol1*days1 = A * A * days1
vol2*vol2*days2 = E * E + A * A * (days2 - 1)
Case 2: You have two options both expiring after the event (same notation as above). A system of equations
vol1*vol1*days1 = E * E + A * A * (days1 - 1)
vol2*vol2*days2 = E * E + A * A * (days2 - 1)
I trust you can figure out how solve a system of linear equations, so I'll leave it at that
Edit: corrected totals.. shame on me
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But does event day E also includes the time from 9:30 - 4? Because the formula i am using in the original post is to calculate the "gap risk" ie. risk of not being able to delta hedge.You can imply event vol from the options implied vol, it's a matter of simple algebra. Two possible cases:
Assumptions: two types of days in the world, event day E and ambient day A (all vols below are daily, so first convert implieds by dividing by 16).
Case 1: You have an option that expires before the event (with vol1 and days to expiry days1) and after (vol2 and days to expiry days2). You get a system of equations
vol1*vol1 = A * A * days1
vol2*vol2 = E * E + A * A * (days2 - 1)
Case 2: You have two options both expiring after the event (same notation as above). A system of equations
vol1*vol1 = E * E + A * A * (days1 - 1)
vol2*vol2 = E * E + A * A * (days2 - 1)
I trust you can figure out how solve a system of linear equations, so I'll leave it at that
vol1*vol1? im surprised a mathmatician like yourself has not figured out the ^ function yet.
. Thanks for clarifying that up for me. I bought a straddle into earnings on URBN today because the gap implied move was 2.50, and the standard deviation of URBN past 44 earnings gaps is 3.2.... even tho the implied move for the event is 3. Doesnt look like it will work out but thats part of the gameFormula in the original post is simply a re-formulation of what I wrote above. An unhedgeable move will be mostly expressed by the wings - i.e. cost of a butterfly, but that's for another lesson since I have to get my shit together and go home finally.
Yea I have been doing some work with the moments into earnings. Ie.. seeing if wings are cheap or expensive based on the kurtosis of the past earnings move. Would you say it makes sense to sell/buy strangles sometimes rather than straddles into earnings? Even if most of the vega/gamma is ATM.
Following is from Euan Sinclair's book. It gives slightly different results than your math. It is because sinclair's formula uses T1 in equation 3.3 instead of T1-1 in your formula.
Robert I have a question for you since you used to make markets. I am trying to buy/sell straddles across earnings and am starting to develop a model to give me some sort of edge. I am curious on how the market makers price the earnings event for illiquid stocks. In your experience how would you or other market makers, price the event vol. Thanks so much.