Exploiting Earnings Volatility: An Innovative New Approach to Evaluating, Optimizing, and Trading Option Strategies to Profit from Earnings Announcements by Johnson Brian

Author:Johnson, Brian [Johnson, Brian]
Language: eng
Format: epub
Publisher: Trading Insights, LLC
Published: 2015-04-06T23:00:00+00:00

Confirmation

Just as we used supplemental evidence from Estimize.com to confirm our directional earnings forecasts, it makes sense to corroborate our analytical results as well. Unfortunately, the earnings volatility framework presented in this book is new and is not widely used by the industry.

However, while writing this book I advised OptionVue on how to use and apply the aggregate implied volatility formula to quantify the effects of earnings volatility before and after earnings events. They subsequently integrated my earnings volatility framework into their OptionVue software. The spreadsheets included with this book and OptionVue’s software modules are the only commercial tools that I am aware of that currently use my earnings volatility framework.

As a result, I was able to enter the optimal UA solution from Figure 5.11 into the OptionVue software and performed a graphical analysis of the strategy on July 23, 2014. OptionVue’s analytical results are depicted in Figure 5.12B. OptionVue’s results do not include the directional or earnings volatility forecasts that we developed throughout this chapter.

The UA stock price is shown on the independent x-axis and the strategy profit or loss (in dollars) is shown on the dependent left-vertical axis. The strategy return as a percentage of required capital is shown on the dependent right-vertical axis. The dashed line represents the strategy results for the “T+0” line, which stands for trade date plus zero days (instantaneous P&L). The solid line depicts the strategy results for the “T+1” line, which represents the P&L for a one-day holding period. These two lines are directly comparable to the strategy results shown in Figure 5.12.

OptionVue also includes two horizontal bars at the bottom of the P&L graph. The shorter top line represents a one-standard deviation price move in the common stock of the underlying security for the time horizon selected, in this case one trading day (T+1). The longer bottom line represents a two-standard deviation move for the same holding period. The one and two-standard deviation forecasts both use the aggregate implied volatility formula to accurately incorporate the effects of earnings and non-earnings volatility over the specified holding period.

While the Integrated spreadsheet model and OptionVue’s model both use the aggregate implied volatility formula, the other components of the two models are completely independent: estimates of earnings volatility, directional bias, normal volatility, vertical skew, horizontal skew, and the IV/price sensitivity. The Integrated spreadsheet and OptionVue results both include estimated slippage and transaction costs. Despite the model differences, the P&L forecasts are quite similar and both clearly support the transaction.

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