As the first quarter ends, the time has come to update Volatility Kings our list of companies having a tendency to experience increasing option implied volatility as their quarterly reporting dates approach.
Increasing implied volatility reflects greater uncertainty or the width of the possible stock price distribution on the report date. However, the degree of uncertainty for the current report may not be comparable. Indeed, some companies are on the list one quarter and not the next while others seem to remain on our list quarter after quarter. Since the focus is on earnings, others with high-implied volatility due to takeover speculation or FDA announcements do not appear along with those lacking sufficient liquidity due to low option volume
Before starting, we note the VIX futures premium remained above 20% all last week, closing Thursday at 21.78%, a level in the past that preceded overbought pullbacks. As we mentioned last week in Digest Issue 12 ?New Uptrend Underway,? May 22, 2015, was the last time the VIX Futures premium was above 20% right after the S&P 500 Index had just made a pivot high of 2134.71 on May 20, 2015, a level not yet exceeded. Since mostly professional tactical traders and hedgers use VIX futures and options and since the prices remain quite high relative the VIX, reflected by the premium, or contango above 20% suggests, the current implied of S&P 500 Index is lower than their expectations. If right, the VIX will soon advance as the index corrects.
Volatility Kings
Starting with the search criteria of stock prices greater than $5 ? when prices are too low there are not usually enough strike prices or liquidity for spreads or other strategies, with the possible exception of short puts with assignment risk.
Options Volume: While this could result in inclusion one quarter and not the next, the objective is to find those candidates with sufficient options liquidity and therefore reasonable bid/ask spreads to use for various multiple leg strategies, such as Calendar Spreads, Butterflies, Iron Condors and others.
1-week average option volume greater than 20K contracts
1-month average option volume greater than 20K contracts
Implied Volatility differential from last quarters? earnings announcement high to the subsequent after reporting low greater than 10% occurring regularly with some flexibility on the regularly occurring requirement as it may vary due to market conditions and special situations.
Starting with the “Top 200 stocks by volume / open interest” link on the left side of the “Rankers and Scanner” section of our home page where we feature a complimentary ranker sample of the top and 200 stocks and ETFs by Options volume and Options open interest using weekly averages.
Deleting those with Implied Volatility differentials less than 10% produces the Volatility Kings list below almost twice the size of the previous 4Q list.
Since the purpose is to find regular volatility opportunities, only those with implied volatility differentials that are greater than 10% from last quarters? earnings announcement high to the subsequent low are included, called “permanent residents,” while newly added ones due to unusual temporary sector conditions such as oil & gas or biotechnology, called “temporary visitors,” may not appear in subsequent quarters.
Price in column 3, are closing stock prices as of Thursday March 24, 2016.
Next Rpt in column 4 is the next expected reporting date. They require checking often as these are only estimates and companies routinely change reporting dates. Time in column 5 is the time during the day to expect the report, where B is before the open, A is after close.
Estimate in column 6 is the current consensus earnings estimate per share, also subject to change before the report date. Some may also have higher or lower ?whisper? estimates. In addition, stock prices are moving on forward guidance as much or perhaps more than revenues and earnings.
Last Q IV in column 7 is the implied volatility index mean (IVXM) of the puts and calls reached just before the last quarterly report, but may not necessarily be relevant this quarter.
IV Min Ex in column 8 shows the implied volatility index mean (IVXM) low after the last earnings report making it easier to compare the pre-report high to the subsequent low. For some, depending upon the last report date, the implied volatility may still be declining.
IV Now in column 9 is the implied volatility index mean, (IVXM) as of Thursday March 24, 2016.
Nike (NKE) and Oracle (ORCL) have just reported so the implied volatility may still declining so compare the current IV Now to the previous IV Min EX to estimate the potential implied volatility decline or the next advance sequence.
IV Est/Now in column 10 is the ratio of the estimated implied volatility to the current implied volatility based primarily on the high reached the previous quarter. Those with higher ratios have a potentially greater opportunity to increase going into their next report date and many have already started increasing anticipating the next report.
Events unrelated to earnings reports can also affect implied volatility, such as changing S&P 500 Index implied volatility as reflected by the VIX now near the lower end of its 52-week range. To help identify implied volatility highs, lows, and forecast where they may go along with other details, make sure to check the volatility charts at either our complimentary Basic Options or our more detailed Advanced Historical Data pages on our website.
Comments and Observations
The typical pattern is for implied volatility to decline for 4-6 weeks after the report date followed by a subsequent rise for about 3-4 weeks before the next report, but they vary with each having its own somewhat unique pattern.
Those with ratios less than 1 are currently experiencing high-implied volatility for reasons that may be unrelated to their upcoming earnings report such as activist activity or reorganization chatter.
Some Strategy Ideas
Frequently calendar spreads, also called time spreads are used for quarterly reporting by selling the near term option with higher implied volatility and buying the same strike price in the deferred month with a lower implied volatility. However, since this position will have short gamma or the rate of change of delta, any large move of the underlying stock on the report date will result in a loss.
The alternative approach, distinguished by the expiration date of the short option relative to the earnings report date has quite different characteristics.
When the short option expires before the report date, the short option implied volatility is less likely to advance while the implied volatility of the deferred long option, expiring after the report is more likely to advance into the earnings report. In addition, the risk of a harmful stock price gap diminishes by closing the spread before the earnings report release. This strategy depends on closing the position one or two days before the short option expires and is thus, truly a time spread designed to capture time decay of the short front option relative to the long option while any implied volatility advance of the deferred option is a bonus.
Option prices continuously change in response to changing expectations. The higher the uncertainty the more valuable the option, implying there is a much wider distribution of possible outcomes. When they become more predictable, the implied volatilities no longer increase dramatically before the reporting dates, option volume usually declines and they disappear from the Volatility Kings?.
Individual investors relying upon the earnings forecasts and playing the expectations game wondering if they may be too high or too low are disadvantaged when anticipating the direction the stock will move after reporting. However, if the implied volatility has risen enough into the report date it may offer an opportunity for a volatility strategy and not rely upon getting the direction right. In addition, since earnings reports reoccur every quarter there may be more than one opportunity, especially for the ones that have a regular pattern of rising into the report dates.