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Volatility Spreads and Earnings Announcement Returns

Last Updated on 10 February, 2024 by Rejaul Karim

In the seminal study “Volatility Spreads and Earnings Announcement Returns,” penned by Yigit Atilgan of Sabanci University, the profound complexities of equity returns in the cauldron of earnings announcements are meticulously unraveled. This scholarly endeavor serves as a beacon of insight into the enigmatic interplay between volatility spreads and stock returns, invoking a resounding mandate to decipher their pivotal relationship.

At its core, this paper evokes the tantalizing premise that if volatility spreads, indicative of price pressures in the option market, are driven by the trading activity of informed investors, the predictability of stock returns should be accentuated during pivotal information events.

Foretelling the intricate symphony between volatility spreads and earnings announcements, the study meticulously navigates a formidable terrain, evidencing a resounding resurgence.

Through incisive analysis, this opus accentuates that during earnings announcements, the abnormal returns to stocks with relatively pricey call options surpass those with expensive put options, affording the reader an entrancing vista into the convoluted interstices of financial markets.

Abstract Of Paper

Prior research documents that volatility spreads predict stock returns. If the trading activity of informed investors is an important driver of volatility spreads, then the predictability of stock returns should be more pronounced during major information events. This paper investigates whether the predictability of equity returns by volatility spreads is stronger during earnings announcements. Volatility spreads are measured by the implied volatility differences between pairs of strike price and expiration date matched put and call options and capture price pressures in the option market. During a two-day earnings announcement window, the abnormal returns to the quintile that includes stocks with relatively expensive call options is more than 1.5 percent greater than the abnormal returns to the quintile that includes stocks with relatively expensive put options. This result is robust after measuring volatility spreads in alternative ways and controlling for …firm characteristics and lagged equity returns. The degree of announcement return predictability is stronger when volatility spreads are measured using more liquid options, the information environment is more asymmetric, and stock liquidity is low.

Original paper – Download PDF

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Author

Yigit Atilgan
Sabanci University

Conclusion

In a spellbinding denouement, “Volatility Spreads and Earnings Announcement Returns,” etches an enduring scholarly testament, weaving an intricately embroidered tapestry, synonymous with the furtive vicissitudes encompassing equity returns during earnings announcements.

The strident reverberations of this inquiry divulge an arresting verity: abnormal returns to stocks with costly call options vastly eclipse those with dear put options during the halcyon phase of earnings announcements.

This watershed finding rendered forth by Yigit Atilgan perseveres, standing resolute against the oscillating tides of volatility spreads, even after being subjected to alternative measures and rigorous controls.

Delving deeper, the study fortifies its intellectual ramparts, accentuating the preeminence of more liquid options, asymmetric information environments, and low stock liquidity in accentuating the predictability of announcement returns, summoning forth a pivotal clarion call for the discerning denizens of financial inquiry.

Related Reading:

A Study in Portfolio Diversification Using VIX Options

Trading the Patience of Mrs. Yellen. A Short Vix-Futures Strategy for FOMC Announcement Days.

FAQ

1. What is the main focus of the research paper “Volatility Spreads and Earnings Announcement Returns,” and how does it contribute to our understanding of stock returns during major information events?

The primary focus of the research paper is to investigate the relationship between volatility spreads, indicative of price pressures in the option market, and stock returns during major information events, specifically earnings announcements. The study explores whether the predictability of stock returns by volatility spreads is more pronounced during earnings announcements. By measuring volatility spreads through implied volatility differences between matched put and call options, the paper aims to contribute insights into the interplay between informed investor trading activity, volatility spreads, and abnormal stock returns during crucial information events.

2. What is the key finding presented in the paper regarding abnormal returns and the relationship between stocks with relatively expensive call options and those with expensive put options during earnings announcements?

The key finding of the paper is that during a two-day earnings announcement window, stocks with relatively expensive call options exhibit abnormal returns that are more than 1.5 percent greater than stocks with relatively expensive put options. This result suggests a notable asymmetry in abnormal returns during earnings announcements based on the costliness of call and put options. The finding holds robustly after employing alternative measures of volatility spreads and controlling for firm characteristics and lagged equity returns.

3. How does the research paper suggest that the predictability of announcement returns is influenced by factors such as option liquidity, information asymmetry, and stock liquidity?

The research paper suggests that the predictability of announcement returns is influenced by various factors. Notably, the degree of announcement return predictability is stronger when volatility spreads are measured using more liquid options. Additionally, an environment with higher information asymmetry enhances the predictability of announcement returns. The paper also underscores the importance of low stock liquidity in accentuating the predictability of returns during earnings announcements. These factors collectively contribute to a nuanced understanding of the dynamics between volatility spreads and stock returns in the context of major information events.

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