eirikb007

Implied Volatiliy a Risk Pre and Post Earnings AMZN AAPL GOOGL

CBOE:SKEW   CBOE SKEW INDEX
I want to point out two things in this post:
1. The elevated implied volatility before earnings on blue chips stocks is per se a risk factor due to high call open interest and the following reduction in implied volatility post earnings .
2. The SKEW index is signaling increasing tail risk.

The first point:

As I’ve pointed out in recent posts, high open interest has been a tailwind for stocks as market makers are short calls and forced to buy the underlying without any other purpose but to hedge.

Before earnings , implied volatility (IV) on stocks rises significantly.

For out-of-the-money options, the delta rises with higher IV (this makes intuitively sense because higher volatility means a higher probability for the option to get in-the-money).

As IV rises before earnings , the sum of the delta dollars rises. This is forcing market makers to increase their notional hedges, i.e. they need to buy more of the underlying when their net short calls (status quo) in order to stay delta neutral.

Post earnings IV falls.

This is a risk when market makers are long the underlying stocks, and traders long the options.

When IV falls (all else equal) the market makers may sell the underlying stock no matter how good the earnings reports are.

The second point:

The SKEW Index is derived from S&P500 options, and measures tail risk, which is the risk for outlier returns.

When the SKEW is 100, the option market is discounting negligible tail risk.

As the SKEW rises above 100, the tail risk is increasing.

The SKEW is not a timing instrument, but worth watching as it reaches extreme levels (now >140).

In summary:
The large cap stocks have had an amazing outperformance as I’ve highlighted in recent posts. Even though they may beat earnings expectations, the structure of the options market may be a headwind post earnings .

The SKEW is signaling higher tail risk.
Disclaimer

The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.