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Earnings play

A position built around a scheduled announcement, where implied volatility is inflated beforehand and collapses immediately afterwards.

The front-month implied-volatility rises into the date because one session now contains most of the expected movement. After the release the uncertainty is resolved and volatility collapses — iv-crush — regardless of which way the stock went.

This makes direction insufficient. A long call can be right about the move and still lose, because the volatility it paid for evaporated. Structures that are short volatility on both legs, or that use the expected-move to set strikes, are the usual way to trade the event rather than the news.

Example: XYZ at $50 the day before earnings, 7-day implied volatility 68%, straddle $4.10 implying a $3.50 move. XYZ opens up $2.20 — a real move, less than implied. The $50 call goes from $2.10 to $2.35 while volatility falls to 29%. Right direction, almost no profit.

Related: iv-crush, expected-move, reverse-iron-condor, volatility-term-structure

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Payoff of a long call at expiryA flat loss equal to the premium below the strike, turning upward at 45 degrees above it.Profit / loss per share08595115125Strike 105Max loss 3 — the premium paidBreakeven 108Profit keeps growingUnderlying price at expiry
Buying a call: payoff at expiry. A 105-strike call bought for 3 loses that whole 3 if the price finishes at or below 105, breaks even at 108, then gains a dollar for every dollar higher. The loss is capped at the premium; the upside is not capped.

Educational only, not advice. Spotted an error? Post in Site Feedback.