Options Trading

How Earnings Announcements Affect Option Prices

The unique behavior of pre-announcement implied volatility

Options are intrinsically forward-looking contracts, so their prices should account for the uncertain stock price impact of an upcoming earnings release.

Public companies routinely release summaries of their operations and performance, including income statements, balance sheets, and other reports. Such events are commonly referred to as earnings announcements.

In the market session following a scheduled announcement, the opening stock price may move quite drastically depending on the earnings report. Empirical studies suggest that the variance of stock price returns on the earnings announcement date can be several times greater than those on other dates.

In addition to the immediate price impact, earnings releases may also affect the drift of the stock price after the announcement over a longer horizon. This empirical observation is commonly referred to as the post-earnings-announcement drift.

Since many public companies also have options written on their stock prices, this motivates us to investigate the problem of pricing equity options prior to an earnings announcement (EA). As options are intrinsically…