The basic idea of the event-driven volatility trading strategy highlighted here is to profit from the pre-earnings run-up of IV and post-earnings volatility crush. With an unclear sense of post-earnings price movement, the idea here is to structure a delta-neutral spread that can benefit from the post-earnings volatility crush.
First, the frequency distribution of the last 10 YUM post-earnings returns:
- From the first image, returns are somewhat contained. They ranged from -6.21% to 7.30% (from my data).
- The volatility crush varied significantly and depended on days to expiration of the current options, current volatility environment, and other variables not seen.
- The current market was pricing-in a 9.44% move in either direction, significantly more than realized historical moves.
From my back test, the market has been wrong on the priced-in move of YUM the last 6 out of the 10 earnings announcements. Fundamental reports were mixed, current quarter EPS estimates pointed towards a week quarter while fiscal year estimates pointed towards a good year. Large order flow should also play a part in the trade structuring but I could not really decipher it with confidence so I took what I could.
Finally, the trade is structured:
Above is the trade I placed with the estimated volatility crush: a 45/50 Oct/Nov double calendar. Earnings were released after hours and the stock is trading at $48.69, well in my sweet spot. At the current after hours price and estimated vol crush, a handsome ~20% overnight return on initial investment is expected. I’ll update tomorrow with actual figures.
Disclosure: in YUM Oct/Nov 45/50 Double Calendar
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