IDEAS home Printed from https://ideas.repec.org/a/eee/empfin/v40y2017icp220-235.html
   My bibliography  Save this article

Earnings announcements and option returns

Author

Listed:
  • Chung, Sung Gon
  • Louis, Henock

Abstract

While prior studies find that returns on option straddles are generally negative, we show that returns on straddles purchased prior to earnings announcements are actually positive. The earnings announcement impact is compounded when the pre-portfolio formation volatility is low (high) and the pre-expiration realized volatility is high (low). Apparently, the average option trader underestimates future volatility before forthcoming earnings announcements, particularly after a period of relatively low volatility, and overestimates future volatility after recent earnings announcements, particularly after a period of relatively high volatility. The overestimation of future volatility after recent earnings announcements also increases with the magnitude of the earnings surprise.

Suggested Citation

  • Chung, Sung Gon & Louis, Henock, 2017. "Earnings announcements and option returns," Journal of Empirical Finance, Elsevier, vol. 40(C), pages 220-235.
    • Handle: RePEc:eee:empfin:v:40:y:2017:i:c:p:220-235
    DOI: 10.1016/j.jempfin.2016.07.010
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0927539816300743
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jempfin.2016.07.010?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Jin-Chuan Duan & Jason Wei, 2009. "Systematic Risk and the Price Structure of Individual Equity Options," The Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1981-2006, May.
    2. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," The Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-451.
    3. Hun‐Tong Tan & Robert Libby & James E. Hunton, 2002. "Retracted: Analysts’ Reactions to Earnings Preannouncement Strategies," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 223-246, March.
    4. Mahani, Reza S. & Poteshman, Allen M., 2008. "Overreaction to stock market news and misevaluation of stock prices by unsophisticated investors: Evidence from the option market," Journal of Empirical Finance, Elsevier, vol. 15(4), pages 635-655, September.
    5. De Bondt, Werner F M & Thaler, Richard H, 1990. "Do Security Analysts Overreact?," American Economic Review, American Economic Association, vol. 80(2), pages 52-57, May.
    6. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    7. Patell, James M. & Wolfson, Mark A., 1979. "Anticipated information releases reflected in call option prices," Journal of Accounting and Economics, Elsevier, vol. 1(2), pages 117-140, August.
    8. Patell, Jm & Wolfson, Ma, 1981. "The Ex Ante And Ex Post Price Effects Of Quarterly Earnings Announcements Reflected In Option And Stock-Prices," Journal of Accounting Research, Wiley Blackwell, vol. 19(2), pages 434-458.
    9. Joost Driessen & Pascal J. Maenhout & Grigory Vilkov, 2009. "The Price of Correlation Risk: Evidence from Equity Options," Journal of Finance, American Finance Association, vol. 64(3), pages 1377-1406, June.
    10. Choy, Siu Kai & Wei, Jason, 2012. "Option trading: Information or differences of opinion?," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2299-2322.
    11. Joshua D. Coval & Tyler Shumway, 2001. "Expected Option Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 983-1009, June.
    12. De Bondt, Werner F M & Thaler, Richard H, 1987. "Further Evidence on Investor Overreaction and Stock Market Seasonalit y," Journal of Finance, American Finance Association, vol. 42(3), pages 557-581, July.
    13. Cohen, Daniel A. & Dey, Aiyesha & Lys, Thomas Z. & Sunder, Shyam V., 2007. "Earnings announcement premia and the limits to arbitrage," Journal of Accounting and Economics, Elsevier, vol. 43(2-3), pages 153-180, July.
    14. De Bondt, Werner F M & Thaler, Richard, 1985. "Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    15. Goyal, Amit & Saretto, Alessio, 2009. "Cross-section of option returns and volatility," Journal of Financial Economics, Elsevier, vol. 94(2), pages 310-326, November.
    16. Krinsky, Itzhak & Lee, Jason, 1996. "Earnings Announcements and the Components of the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 51(4), pages 1523-1535, September.
    17. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    18. Kaushik I. Amin & Charles M. C. Lee, 1997. "Option Trading, Price Discovery, and Earnings News Dissemination," Contemporary Accounting Research, John Wiley & Sons, vol. 14(2), pages 153-192, June.
    19. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    20. Wen Jin & Joshua Livnat & Yuan Zhang, 2012. "Option Prices Leading Equity Prices: Do Option Traders Have an Information Advantage?," Journal of Accounting Research, Wiley Blackwell, vol. 50(2), pages 401-432, May.
    21. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    22. repec:bla:jfinan:v:53:y:1998:i:2:p:431-465 is not listed on IDEAS
    23. Tuttle, Brad & Coller, Maribeth & Burton, F. Greg, 1997. "An examination of market efficiency: Information order effects in a laboratory market," Accounting, Organizations and Society, Elsevier, vol. 22(1), pages 89-103, January.
    24. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    25. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
    26. I. Krinsky & J. Lee, 1996. "Earning Announcements and the Components of the Bid-Ask Aspread," Quantitative Studies in Economics and Population Research Reports 313, McMaster University.
    27. Owen Lamont & Andrea Frazzini, 2007. "The Earnings Announcement Premium and Trading Volume," NBER Working Papers 13090, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Li, Wanyun, 2022. "Disclosure of internal control material weaknesses and optimism in analyst earnings forecasts," International Journal of Accounting Information Systems, Elsevier, vol. 44(C).
    2. Jonathan A. Milian, 2023. "The Efficiency of Weekly Option Prices around Earnings Announcements," JRFM, MDPI, vol. 16(5), pages 1-14, May.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bernales, Alejandro & Guidolin, Massimo, 2014. "Can we forecast the implied volatility surface dynamics of equity options? Predictability and economic value tests," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 326-342.
    2. Suresh Govindaraj & Yubin Li & Chen Zhao, 2020. "The effect of option transaction costs on informed trading in the options market around earnings announcements," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(5-6), pages 615-644, May.
    3. Peter Christoffersen & Ruslan Goyenko & Kris Jacobs & Mehdi Karoui, 2018. "Illiquidity Premia in the Equity Options Market," The Review of Financial Studies, Society for Financial Studies, vol. 31(3), pages 811-851.
    4. Ramachandran, Lakshmi Shankar & Tayal, Jitendra, 2021. "Mispricing, short-sale constraints, and the cross-section of option returns," Journal of Financial Economics, Elsevier, vol. 141(1), pages 297-321.
    5. Goyal, Amit & Saretto, Alessio, 2009. "Cross-section of option returns and volatility," Journal of Financial Economics, Elsevier, vol. 94(2), pages 310-326, November.
    6. Choy, Siu-Kai, 2015. "Retail clientele and option returns," Journal of Banking & Finance, Elsevier, vol. 51(C), pages 26-42.
    7. Lin, Zih-Ying & Chang, Chuang-Chang & Wang, Yaw-Huei, 2018. "The impacts of asymmetric information and short sales on the illiquidity risk premium in the stock option market," Journal of Banking & Finance, Elsevier, vol. 94(C), pages 152-165.
    8. Kevin Aretz & Ming-Tsung Lin & Ser-Huang Poon, 2023. "Moneyness, Underlying Asset Volatility, and the Cross-Section of Option Returns," Review of Finance, European Finance Association, vol. 27(1), pages 289-323.
    9. Haehean Park & Baeho Kim & Hyeongsop Shim, 2019. "A smiling bear in the equity options market and the cross‐section of stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(11), pages 1360-1382, November.
    10. Chichernea, Doina & Huang, Kershen & Petkevich, Alex & Teterin, Pavel, 2024. "Options trading imbalance, cash-flow news, and discount-rate news," Journal of Empirical Finance, Elsevier, vol. 77(C).
    11. Levi, Shai & Zhang, Xiao-Jun, 2015. "Asymmetric decrease in liquidity trading before earnings announcements and the announcement return premium," Journal of Financial Economics, Elsevier, vol. 118(2), pages 383-398.
    12. Byun, Suk-Joon & Kim, Da-Hea, 2016. "Gambling preference and individual equity option returns," Journal of Financial Economics, Elsevier, vol. 122(1), pages 155-174.
    13. Baeho Kim & Da‐Hea Kim & Haehean Park, 2020. "Informed options trading on the implied volatility surface: A cross‐sectional approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(5), pages 776-803, May.
    14. Kanne, Stefan & Korn, Olaf & Uhrig-Homburg, Marliese, 2023. "Stock illiquidity and option returns," Journal of Financial Markets, Elsevier, vol. 63(C).
    15. Kothari, S. P., 2001. "Capital markets research in accounting," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 105-231, September.
    16. Rebecca N. Hann & Heedong Kim & Yue Zheng, 2019. "Intra-industry information transfers: evidence from changes in implied volatility around earnings announcements," Review of Accounting Studies, Springer, vol. 24(3), pages 927-971, September.
    17. Kanne, Stefan & Korn, Olaf & Uhrig-Homburg, Marliese, 2016. "Stock Illiquidity, option prices, and option returns," CFR Working Papers 16-08, University of Cologne, Centre for Financial Research (CFR).
    18. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    19. Andrea Frazzini & Lasse Heje Pedersen, 2022. "Embedded Leverage [Asset pricing with liquidity risk]," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 12(1), pages 1-52.
    20. Tyler Muir & Erkko Etula & Tobias Adrian, 2011. "Broker-Dealer Leverage and the Cross-Section of Stock Returns," 2011 Meeting Papers 1448, Society for Economic Dynamics.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:empfin:v:40:y:2017:i:c:p:220-235. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jempfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.