I always used to wonder how much jump in prices is the market really implying right before an earnings or another important announcement. My research regarding the concept led me to this book " Volatility Trading" by euan sinclair. There he clearly shows how to calculate the implied jump in the stock by options prices. The Strategy is to sell the options so that one can take advantage of the fact that implied volatility usually drops after an announcement. So we will be basically short volatility. one should also expect that the front month implied volatility should be greater than that of further expiration implied volatility.

First, assuming, sigma_1 as the front month implied volatility and sigma_2 as the second month implied volatility, forward volatility,

sigma_12 is given by

The volatilty attributed to the event is the difference between front month volatility and forward volatility.

Sigma_E =

The Expected Jump is :

A Trader needs to compare this estimate to that of his own estimate of how much the stock is going to jump after the announcement and should trade accordingly. Not definitely for the faint hearted.

## 6 comments:

We look at the implied volatility skew between the front-month and the 2nd term options to get an estimate of what the market expects in terms of an earnings-gap move. It isn't perfect, but gives a reasonable estimate.

Fred Ruffy

WhatsTrading.com

so, this formula gives the expected jump as percentage of the stock price?

van wrinkle: It gives how much percentage the stock is expected to jump from now to the next month. This is in terms of percentage.

What are the Ts? expiration date? i don't think i understand what format they go in as.

This is obviously a great post. Thanks for the valuable information and insights you have so provided here. I will often visit your blog to know more about stocks.

digital options

The information shared here is of great use for those who trade in stocks.

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