This is the first time for this year that we are entering “Earnings Season.” Each quarter we experience this. Most companies run their business based off the calendar, where they start the year January 1st and end on December 31st. Their quarters would end on March 31st, June 30th, September 30th, and December 31st. Usually companies need 3-5 weeks to gather all the information together to report their earnings for the prior quarter. This earnings season is reporting for the last quarter of the year ending in 2014. Every company is free to decide when their fiscal year begins. Not every company will be reporting. Some companies might begin their year in February or March.
During this time of year, we can see some extreme volatility. We can see stocks gap up significantly. Netflix closed at $348.80 on Tuesday night. They announced earnings after the market closed. The news caused Netflix to open yesterday at $414.64. That was almost a 19% increase over night. Today it closed at $428.44, another 4.5% move.
Of course, on the bearish side, we have F5 Networks closed at $125.95 yesterday. Earnings were announced after the market close. Today the stock opened at $108.65 before closing at $113.40. That was almost a 14% drop at the open before finishing down just under 10% for the day.
With the potential for these big price movements up or down, option prices are going to be more expensive during earnings season. This is known as implied volatility. With expectations of potential big moves, traders are willing to pay more for the options, creating a demand for options. With increased demand, option prices are driven up to higher than normal prices or an increase in the implied volatility. Once earnings are announced and stocks make their move, the expectation of another big move is gone. There is not another earnings report (at least for 3 months) to cause a big move, so traders are not willing to pay as much for the options. This lack of demand for the options decreases the option prices.
For most stocks, that means option prices are pretty expensive right now. But after earnings are released, option prices for those stocks are very cheap, making it a great time to be buying options
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