YUM Earnings Trade (Part 1)

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:

Next, the volatility crush of the last 10 earnings announcements:

Third, the current market:

Here are some takeaways:

1. From the first image, returns are somewhat contained. They ranged from -6.21% to 7.30% (from my data).
2. The volatility crush varied significantly and depended on days to expiration of the current options, current volatility environment, and other variables not seen.
3. 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