What is an Implied Earnings Move?
The implied earnings move is an easy metric to explain and tricky for new investors to apply. An implied move can basically be defined as the percentage level by which a stock option will move after a dramatic event like earnings announcements which is where the term implied earnings move comes from. It could also come from review announcements, or anything else that classes under binary events.
Explaining Implied Earnings Move
The implied earnings move is simple to understand. It is the amount stated in percentage that a stock option will move upwards or downwards is predicted to increase or decrease after any binary event, like the release of an earnings report.
The predicted value is often linked to implied volatility. For instance, if stock option A has an implied earnings move rate of 10% after its earnings release, traders and investors can expect the price to move in a range of 10% in either direction. This information holds a lot of value for traders that are making trades around this time.
The implied earnings move movement could be both upwards or downwards and is usually calculated by a formula. The implied earnings move rate is popular around the end of financial quarter when companies usually announce their earnings.
What the Implied Earnings Move Tells Us
The implied earnings move is a forecast of expected variations in a stock’s market price after the company announces its earnings for the quarter. The implied earnings move is useful for investors. It offers them a range of low to high prices to expect in options after a binary event.
If an option's implied earnings move rate is expected to be high, its options contracts will have a higher premium since there is potential for increased profits (or possibly losses) and thus more risk for option contract seller.
Low rates in the implied earnings move may cause option contracts to be discounted or have low demand due to the anticipated low return and so has lower risk to the option seller.
Some experienced analysts and investors also state that implied earnings move shows a stock’s price trend.
While this can be correct for some cases, it is a misconception. What implied earnings move indicates is the extent of price variation in any direction. It is the degree to which earnings announcement will influence an option’s price.
How to Calculate the Implied Earnings Move
The Implied Earnings Move of a stock or option for any binary event can be calculated by estimating 85% of the rate of the closest month end expiry (front of the month) at the money (ATM) option.
The calculation is done by taking the market rate for the front-of-the-month money call and the market rate for the front-of-the-month ATM put. Both values are added, and the result is multiplied by 85%.
An easier way to get the result for the implied earnings move for any earnings event is to take the (At the money) straddle, add the out-of-the-month (OTM) strangle and split the result by 2.
Both can be done through platform calculators, and many platforms offer up-to-date implied earnings move values in real-time.
What the Implied Earnings Move Means
To apply implied earnings move to any investment and see what it means an investor should remember its definition, that it shows the rate of fluctuation in a stock’s price after a significant financial event.
The value range forecasted by the implied earnings move allows investors to make more informed investment choices regarding the stock.
For instance, the implied earnings move of an option projects that it can face a $10 rise or fall at its earnings announcement. If this $10 increase is acceptable for traders, they can book their deals for the stock or its options around the binary event.
Implied earnings move rates also gain importance in cases where the rates are experiencing higher volatility due to earnings releases, industry happenings or any other binary event.
Most binary events push up volatility levels due to higher speculation, higher risk and confusion about price trend expectations. The implied earnings move rate gives traders a range to move freely to book their deals.
Users should remember that the implied earnings move is only effective when used for binary events. The validity of implied volatility crush after earnings (also known as premium crush) and all of the other variables linked with implied volatility are too complex to correctly connect with the implied earnings move over an extended period.
The similarity between Implied Volatility and Implied Earnings Move
The implied volatility shows traders the expected movements of a stock’s price during the life of an option. The moves in market prices are important as the implied volatility level determines the pricing effect of time value.
As price and performance expectations change, option prices also change. Implied volatility directly affects the market for stocks is also affected by their price movement expectations.
During binary events, expectations or demand rises, which will also increase the implied volatility. The implied earnings move rate will help determine the extent of the implied volatility range expected.
Implied earnings move is a close ally of the better-known and more versatile Implied volatility. Implied Volatility gives traders an idea of stock volatility during the life of an option. This makes the formula important because its rate decides the level of influence time value exerts on a stock.
A drawback of implied earnings move that is common to that of Implied volatility is that it doesn’t predict the trend of price fluctuation. However, it offers a reliable working range in which traders can work to reduce risks and raise trade yields.
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