Too Good to Be True? An Analysis of the Options Market's Reactions to Earnings Releases

Forthcoming, Journal of Business Finance & Accounting

32 Pages Posted: 24 Jan 2011 Last revised: 29 Jul 2016

See all articles by Yan Lu

Yan Lu

University of Central Florida - College of Business Administration

Sugata Ray

University of Alabama - Department of Economics, Finance and Legal Studies

Date Written: January 22, 2016

Abstract

Using option implied risk neutral return distributions before and after earnings announcements, we study the option market's reaction to extreme events over earnings announcements. While earnings announcements generally reduce short term uncertainty about the stock price, very good news does not reduce uncertainty and slightly bad news actually increases uncertainty. Cross-sectional tests of realized volatility reductions are largely in line with option implied findings, except for cases where very good news is released, which suggests an irrational level of perceived uncertainty in options markets following very good news. We also find that left tail probabilities decrease over earnings releases while right tail probabilities increase. We interpret these findings as evidence of maintained investor expectations that very good news is generally not released during earnings announcements combined with unwarranted skepticism at the release of such news.

Keywords: Earnings Announcements, Option Implied Distributions, Tail Risk

JEL Classification: G14, G17, G24

Suggested Citation

Lu, Yan and Ray, Sugata, Too Good to Be True? An Analysis of the Options Market's Reactions to Earnings Releases (January 22, 2016). Forthcoming, Journal of Business Finance & Accounting, Available at SSRN: https://ssrn.com/abstract=1746242 or http://dx.doi.org/10.2139/ssrn.1746242

Yan Lu

University of Central Florida - College of Business Administration ( email )

PO Box 161400
Orlando, FL 32816
United States

Sugata Ray (Contact Author)

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

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