There has been nothing normal about 2020 and we are just a bit over 25% of the way through the year. Before the Covid-19 pandemic began to turn our world upside down we got earnings announcements covering 2019 that did not take what was on the horizon into account. In the next couple of weeks many of the biggest components of the Nasdaq-100 will report earnings covering the first three months of 2020. Many market watchers felt like the upcoming earnings season would be a non-event. However, the option market is now bracing for higher individual stock volatility and the Nasdaq-100 is showing a little bump in volatility expectations during the last week of April.
The five largest components of the NDX are Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Facebook (FB) and Alphabet (GOOG / GOOGL). All five companies are set to report the week ending May 1 and the option market appears to have adjusted in a manner similar to previous earnings seasons.
Using the weekly options expiring April 24, May 1, and May 8, the implied volatility for at-the-money options was determined by averaging the two nearest call and put strikes expiring on each day. As expected in normal times, there is a bump in the implied volatility priced in by the options expiring the Friday after earnings. The implied volatility levels used in the chart below was recorded at midday on Friday April 17.
Data Source: Bloomberg
To get an idea of what the market is expecting out of earnings relative to a more normal time period, the same numbers for each of these companies was used to calculate the same comparison going into earnings three months ago. Unfortunately, GOOG/GOOGL, reported a different week than the other four companies so the various implied volatility charts do not cover the same dates, instead on the Friday two weeks before earnings the at-the-money implied volatility was calculated. This was Jan. 17 for all companies except for Alphabet which was Jan. 24.
Data Source: Bloomberg
The week before implied volatility for all five companies is very low. FB, AAPL, AMZN and MSFT reported their earnings the week after a four-day week which likely put some pressure on the “Week Before” volatility. However, there is no holiday in the mix for the GOOG/GOOGL numbers and that curve is very similar to the other four curves.
Option pricing this quarter is similar to what we expect around earnings with elevated implied volatilities priced in by options that expire just after an earnings announcement. However, this quarter the options expiring the week before earnings have implied volatilities that are more in line with the pricing of options that expire just after earnings. There may be some calendar spread opportunities to take advantage of this unique situation and we will be keeping an eye out for any trades that appear to take advantage of elevated volatility the week before earnings.
Generally broad-based index options do not adjust pricing in anticipation of earnings announcements. However, the five companies that report the same week this quarter represent about 45% of the weighting in the NDX. There is some slight earnings seasonality that shows up in NDX option pricing with slightly elevated implied volatility priced into the non-standard NDX options expiring just after a large portion of the indices’ membership is reporting earnings. This shows up somewhat in the options expiring on May 1 this year.
Data Source: Bloomberg
Both the Friday April 24 and May 1 options are pricing in some elevated volatility expectations. About 10% of the NDX reports the week ending April 24, but near-term market volatility expectations remain elevated as day to day reactions to news continue to be fairly extreme relative to the past few years. The peak on May 1 compares to the final data point (May 8) in a similar manner as the option volatility expectations for the five big NDX companies reporting just before May 1 expiration.
The April 24 and May 1 relationship may offer calendar spread opportunities if there is an expectation that the NDX will continue to experience less extreme day-to-day moves over the course of the week of April 24 and then see a potential pick up in price action associated with earnings announcements. This is something else worth keeping an eye on and any interesting trades will be highlighted in a timely manner.
Nothing about 2020 has been normal and the volatility expectations for both individual stock options as well as broad-based index options continues to be elevated, despite a rebound in stocks and a little less realized volatility. Earnings season is impacting both May 1 individual stock option prices as well as NDX option prices. This higher volatility may offer option traders more alternatives to trade around earnings than in a normal quarter.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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Russell Rhoads, PhD, CFA
Russell Rhoads, Phd, CFA is a highly regarded strategist, educator, and consultant – among other things he is perhaps best known as the author of Trading VIX Derivatives, the textbook in the space.
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