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Anticipating Uncertainty: Straddles around Earnings Announcements

Published online by Cambridge University Press:  13 September 2018

Chao Gao ,
Yuhang Xing  and
Xiaoyan Zhang
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Abstract

Straddles on individual stocks generally earn negative and significant returns. However, average at-the-money straddles from 3 days before an earnings announcement to the announcement date yield a highly significant 3.34% return. The positive returns on straddles indicate that investors underestimate the magnitude of uncertainty around earnings announcements. We find that positive straddle returns are more pronounced for smaller firms and firms with higher volatility, higher kurtosis, more volatile past earnings surprises, and less trading volume/higher transaction costs. This suggests that when firm signals are noisy, and/or when it is costlier to trade, investors underestimate the uncertainty associated with earnings announcements.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 6 , December 2018 , pp. 2587 - 2617
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

We thank an anonymous referee, Robert Battalio, Paul Malatesta (the editor), Jun Pan, and seminar participants at the Shanghai Advanced Finance Institute, Syracuse University, and Tsinghua University for helpful comments. Both Xing and Zhang are also affiliated with the China Academy of Financial Research at Shanghai Jiao Tong University. Zhang is also affiliated with Tsinghua University.

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