Volatility spread and stock market response to earnings announcements

Document Type

Article

Publication Date

10-1-2020

Abstract

Using a broad sample of earnings announcements, we find a monotonic increase in the spread between call and put implied volatilities as it gets closer to the earnings announcement date. The steady build-up of volatility spread in the days leading up to the announcement date, coupled with the predictive power of cumulative abnormal implied volatility spread on subsequent announcement returns, suggests that informed traders are the driving force behind the option market activities prior to earnings announcements. Such informed trading, as proxied by the abnormal implied volatility spread, increases rather than decreases the stock market response to earnings announcements after controlling for an array of firm and announcement characteristics. This effect is most pronounced when the pre-earnings option trading volume is heightened. Overall, our findings lend strong support to the notion that informed options trading immediately before earnings announcements helps alleviate the stock market under-reaction to earnings announcements and make it closer to a complete response.

Identifier

85048737287 (Scopus)

Publication Title

Journal of Banking and Finance

External Full Text Location

https://doi.org/10.1016/j.jbankfin.2017.04.002

ISSN

03784266

Volume

119

Fund Ref

Bucknell University

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