Monday, June 22, 2009

Volatility Crush

Let's finish up the whole RIMM earnings saga by posting a before and after of implied volatility. As previously discussed, option premiums get bid up in anticipation of the earnings announcement, causing a lift in implied volatility. As traders are purchasing calls or puts, they willingly bid up or pay more for these options as they *know* the stock will gap one way or another in reaction to the earnings announcement. Thus, they hope they will be compensated for paying up for these options by a large favorable gap in the underlying. In the first picture below you can see RIMM options IV was sitting around 72% pre- announcement.

After the announcement and subsequent gap in stock price, option owners generally begin to unload their options, hopefully at a profit, but most often I would bet at a loss. As all of this supply begins to be absorbed into the options market, generally IV will plummet from its pre-earnings lofty levels. The picture below depicts the post announcement IV crash in RIMM to around 50%.
You'll see this dynamic play out time and time again with earnings announcement- so if you decide to play options around earnings, make sure you take into consideration the typical changes in volatility that occur.


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