“FANG” is an acronym created by Jim Cramer about four, very popular, technology companies, Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (Alphabet A or symbol GOOGL). The latter two have already reported earnings which were disappointing to Wall Street. Netflix, the first to report, closed on Friday with a price 11.50% lower than the price before its announcement. Google (Alphabet A or GOOGL) closed down 5.41% on Friday after its announcement. Earnings reports this week include Facebook, Amazon and Apple (although not considered part of the FANG group, but seemingly just as important).
Clearly the market perception of volatility in the three stocks with upcoming earnings is visible by comparing the Implied Volatility of the Options to the Historical Volatility of the Stock. In the case of Apple, the discrepancy between the two is the least. In the Table below, the Implied Volatility of AAPL is 28.39% while the Historical Volatility is 21%. Whenever trading options, be sure to analyze the Implied Volatility of the actual Strike Price you are trading and whether that particular Implied Volatility has meaning. The less time there is before expiration, the less meaningful the Implied Volatility Analysis becomes. In addition, analyzing liquidity, as shown in the Table, provides a reason to stay away from Options that give up too much of an edge. SPY (SPDR S&P500 ETF) is my standard bearer for good liquidity and even many of its Options Contracts do not provide the Liquidity necessary for establishing a position. A liquidity percentage of 1-2% is probably pretty reasonable for a Stock depending on its Volatility. (That’s for a later discussion.)
In the case of Facebook, you can see that while the Historical Volatility is 24% the Implied Volatility is in excess of 40% and for Amazon, the numbers are 21% compared to 43%. There is almost always a significant Implied Volatility Premium in Stocks (meaning higher options prices) before Earnings Announcements. These announcements tend to cause significant price movements, causing the stock trade in a manner that is difficult to predict. If you have an opinion about a Stock and are prepared to take a position in the Stock, then Earnings Season provides an excellent opportunity to establish a position. If you examine the Table below you can see how the Implied Volatility of both Google and Netflix, both post-earnings announcement, is much lower than the Historical Volatility. This is a result of the syndrome “buy the rumor, sell the news”. While Options Prices are typically high before an announcement, once the news has hit the market and the market has made its move, there is no longer a reason to pay excessive premiums for options.
In addition to the top of the Table which provides information about volatility, the day’s trading activity and the stock’s average true range and relative strength index. The bottom portion of the Table provides an example of how to look at the pricing of Puts in Amazon and Apple. The Table provides the Prices and Implied Volatilities of certain Strike Prices. It gives you the opportunity to analyze the Implied Volatility Skew of the Options. If you do not understand some of the elements in this article take a look at the Options Guide which will clarify things. In addition, the Table provides some important Greeks, Liquidity Information and the distance of the Strike to the current Trading Price. If you are interested in Trading Options prior to an Earnings Announcement, make sure you choose the appropriate Options Trading Strategy to meet your risk/reward requirements. While the Implied Volatility and Options Prices may seem inflated, if you’ve Sold the Amazon 560 Puts for 8.50 and AMZN opens 20% lower, the Premium you received will seem quite small. Earnings season provides tremendous trading opportunities, but make sure you understand all of the facets of trading before getting involved.
OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.