What is the earnings implied move and how is it calculated?

The straddle method

An at-the-money straddle, one call and one put at the strike nearest the stock price, pays off if the stock moves far enough in either direction. Its price is the market's estimate of how far that is likely to be. Divide the straddle price by the stock price and you have the implied move as a percentage, for the period up to that expiry.

The straddle is a good shortcut, and it is the number most traders quote. Strictly, under textbook pricing the straddle approximates the expected size of the move rather than a precise one-standard-deviation band, and traders use different conventions for converting one into the other. Some scale the straddle, others quote it as is. What matters is knowing which convention a figure uses and sticking to it.

Pick the right expiry. The relevant contract is the first one that expires after the report. If earnings come after the close on Thursday and the next expiry is Friday, that Friday straddle is almost entirely an earnings bet.

Separating the event from the ordinary days

The straddle covers every day up to expiry, not just the earnings day. If the first expiry after earnings is three weeks away, a good part of its price reflects ordinary movement rather than the report. To isolate the event, traders compare implied volatility across expiries.

The idea is that the expiry spanning earnings carries the normal daily variance plus one extra lump for the event, while an expiry before earnings carries only normal days. Variance adds over time, so subtracting the normal days' variance from the earnings expiry's total variance leaves an estimate of the event's own variance. The square root of that is the implied earnings-day move.

With weekly options available on most liquid stocks, the shortcut usually works well enough: the nearest post-earnings weekly straddle is dominated by the event.

A worked example of isolating the event

Say a stock's options expiring the week before earnings trade at 30 percent implied volatility with 10 days left, and the options expiring after earnings trade at 50 percent with 20 days left. Variance is volatility squared times time, so the earlier expiry carries 0.09 times 10, or 0.9 units, and the later one 0.25 times 20, or 5.0 units. If the extra 10 ordinary days in the later expiry carry about another 0.9 units, roughly 3.2 units are left for the event.

Convert back to a single day by taking the square root of that event variance divided by the number of days in a year used for the calculation. With 252 trading days, that is the square root of 3.2 divided by 252, which comes out to about 11 percent. That is the market's implied one-day earnings move, separated from the ordinary days around it. The arithmetic is approximate, but it shows why a far-off straddle overstates the event when used raw.

Comparing with past reactions

An implied move means more next to the stock's own history. If a stock has typically moved around 4 percent on earnings over recent reports and the options are pricing 8 percent, the options are expensive relative to that history. If they price 3 percent, they are cheap.

History has limits, though. A company that has just changed its business, faces an unusual uncertainty or is reporting into a very different market environment may deserve a larger implied move than its past reactions suggest. The options market sometimes knows things a backward-looking average does not.

The comparison also depends on what you measure. Close-to-close moves around the report include the overnight gap plus the following session; some traders measure only the gap. Be consistent with whatever the implied move is being compared against.

What happens after the report

Once the report is out, the event premium collapses, which is the IV crush. A straddle buyer needs the stock to move more than the implied move to profit, after accounting for the remaining time value. A move exactly equal to the implied move usually leaves the straddle near break-even before costs.

Skew adds direction to the picture. If puts in the earnings expiry are priced at higher implied volatility than calls, the market is paying more for downside outcomes. That does not predict a decline, but it describes where the market sees the larger risk.

It is also worth remembering that the implied move is symmetric by construction: the straddle pays for a move in either direction. It is not a target in either direction, and a stock that moves less than implied in either direction has, from the options market's point of view, had a quiet report.