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2017issue C0124-27

One-day earnings volatility, ratio spreads and butterflies

A large holding that reports the next session is treated as a short-horizon volatility-regime problem. Two implied-volatility strips isolate a one-day jump, then a 1x2 put ratio or a put butterfly encodes that jump as one net debit and one expiration payoff table.

  • A next-session earnings print can invalidate a chart-based directional view, so event-based option structures replace the original opinion.
  • A rise in implied volatility on options that span the announcement is treated as a leading, quantitative reading of earnings uncertainty and jump risk.
  • One-day event volatility is isolated in variance space from two same-strike maturities, because variance is additive and volatility is not.
  • Elevated implied volatility makes an outright near-term put costly, so a 1x2 put ratio or a three-strike put butterfly restates the event as a single net debit and payoff table.
Entries in this reading3 entries
Current trackButterfly spread29 readingsOption spread138 readingsImplied volatility analysis176 readings

A next-session print can break a chart view

A large portfolio holding set to report results the next session is presented as a case where chart-based opinions can fail. A downside print can produce a sharp drop.

When a stock-specific event can prove a directional view wrong, event-based options structures are specified instead of relying on the original opinion.

Implied volatility as a reading of jump risk

An implied-volatility rise in options that span the announcement is treated as a leading, quantitative reading of earnings uncertainty and jump risk.

Implied volatility is a forward-looking options-market price of uncertainty, including the extra jump premium that appears in the maturity that spans an earnings release.

Isolating one-day event volatility

One-day event volatility is isolated from two same-strike maturities in variance space, because variance is additive and volatility is not. Sequential variances may be added, whereas volatilities may not be added directly.

A 23 percent and 28 percent pair becomes 5.29 percent and 7.84 percent variance and a combined 36.24 percent volatility.

A July 2016 illustration

In the July 2016 illustration, a four-day 46 percent strip and a nine-day 28 percent strip produce a one-day event volatility of 6.03 percent, or about a 9.04 move on a 150 price, using 256 sessions so the square root is 16.

Near-term strikes and weekly listings

Near-term at-the-money options are identified as the most liquid strikes with tighter spreads. Weekly listings are described as improving price efficiency for the event toolbox.

A 1x2 put ratio as a lower-debit hedge

Elevated implied volatility is said to make outright near-term options a costly hedge, so a 1x2 put ratio is built by buying the 150 put at 4.05 and selling two 141 puts for 2.60, for a 1.45 net debit versus 4.05 alone.

The ratio spread sells more out-of-the-money contracts than it buys at the money in order to cut the net debit of an event hedge. The short 141 strike is placed at the roughly 9-point modeled downside from a 150 spot, and the expiration payoff table peaks at 8 when the stock is at 140.

The option spread buys and sells related contracts so the event hedge is expressed as one net premium and one expiration payoff table.

A put butterfly when the stock is not already held

A long-140, short-two-145, long-150 put butterfly is offered as an event structure for traders who do not already hold or short the stock before the print.

The butterfly spread is long the wings and short twice the middle strike, used here as a defined event payoff when the underlying is not already held.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
12 of 18 in the Butterfly spread track
201722-27 pp.Next on Butterfly spreadBuilding a staggered broken-wing butterfly bookOpen weekly SPX or ES options 70 to 85 days out, plan to exit 15 to 20 days before expiration, and add a new line about every two weeks so four or five trades overlap.
All readings on this track · 18 readings
  1. 2003Specify a butterfly as one range procedure
  2. 2006Index volatility alignment, skews, and butterfly construction
  3. 2006Oil proxies, volatility regimes, and bounded overlays
  4. 2007Pairing a double-diagonal overlay with an income butterfly
  5. 2008Range-bound butterfly debit versus iron credit
  6. 2008Iron butterfly payoff construction in volatile crude
  7. 2010Constructing directional out-of-the-money butterfly spreads
  8. 2010Modified butterfly and calendar spreads in high-priced names
  9. 2011Broken-wing put butterfly: credit, vega, and assignment
  10. 2013A live-cattle call butterfly is a different risk object than an outright call
  11. 2017Put butterfly payoff construction from an implied move and premium
  12. 2017One-day earnings volatility, ratio spreads and butterflies
  13. 2017Building a staggered broken-wing butterfly book
  14. 2017Below-the-money butterfly spreads sized by volatility regime
  15. 2018Why day-one option risk curves misread theta, calendars, and butterflies
  16. 2019An expected-value filter for defined-risk option spreads
  17. 2019Failed breakout as a setting for an out-of-the-money put butterfly
  18. 2020Limited-risk call butterfly construction in volatile oil
By fieldOptions and volatility435 readingsBy year2017182 readings
All 29 readings tagged Butterfly spread
Also on Butterfly spread5 readings
2011Broken-wing put butterfly: credit, vega, and assignment2019Failed breakout as a setting for an out-of-the-money put butterfly2020Limited-risk call butterfly construction in volatile oil2003Specify a butterfly as one range procedure2008Iron butterfly payoff construction in volatile crude