Whenever earnings season comes around, it has the potential to shake up the markets in a big way.
You often hear traders say they sell options ahead of earnings because you’ll get caught in a volatility crush…
But if you’re one of the millions of retail traders who don’t know about this common mistake, it could cost you.
Don’t get it twisted… the “vol” that’s getting crushed here is implied volatility, not volume.
Implied volatility is the amount the market thinks a stock price can move…
And it can have a massive impact on what we trade, and how we trade it.
So today, I’m diving deep into the world of implied volatility — how it works, how to find it and what to do about it.
Earnings Options Mistakes: Don’t Get Caught by the Volatility Crush
Some stocks that move a lot day to day like Netflix Inc. (Nasdaq: NFLX), Nvidia Corp. (Nasdaq: NVDA) and Tesla Inc. (Nasdaq: TSLA) are said to have high implied volatility year-round.
But individual stocks also have high implied volatility around “unknown” events — like earnings. Why is that? Because there’s a ton of things that can happen, and they often lead to earnings options mistakes.
A company can beat or miss expectations. Sometimes, executives can say something that moves the stock one way or the other. Stocks usually make big moves about four times a year, and that’s typically around earnings.
So it makes sense that when a stock is expected to have a big move, this can drive demand in the options market.
You’ll have traders who think a stock is going to have a blowout quarter and want to buy calls. You’ll also have contrarians who think that same stock will crash, and they’ll buy puts.
And then there are traders who want some insurance on their underlying position for earnings, and they’ll buy puts to hedge against that unknown event in case the stock tanks.
That spike in demand means option premiums will be more expensive than they would without that event.
Well, the same thing can happen in reverse, moving away from unknown events.
Once those reports are in the books, all of that speculation about what “could” happen that drove prices up — the volatility — goes away. That’s when volatility crushes the value of the options. So how do you avoid this earnings options mistake?
In the video, we’ll look at some historical examples with Apple Inc. (Nasdaq: AAPL) and Amazon.com Inc. (Nasdaq: AMZN), and see firsthand how a vol crush affects options prices around “unknown” events.
In the meantime, you can follow me @LanceIppolito on Twitter, Instagram and our YouTube channel for more trading insights and tips. And as always, you can find me right here talking stocks and options trading — and printing money — on WealthPress.com!