The behavior of implied volatility surrounding an earnings announcement is a fairly reliable phenomenon. The elevated demand for option contracts lifts implied volatility into the event, while the excess supply of options drops implied volatility after the event. While the pre-earnings ramp tends to be gradual, the post-earnings drop tends to be a rapid event.
This predictable drop in volatility following earnings is why most savvy traders like to hold short vega positions heading into the announcement.
Every once in a while you’ll see implied volatility buck the conventional trend and remain elevated even after an earnings announcement. The implied volatility of McMoRan Exploration (NYSE:MMR) options have just followed just such a path. Even though the uncertainty associated with MMR’s earnings on July 17 is now in the rear-view mirror, implied volatility still sits at the upper end of its range and at a hefty premium to recent historical volatility.
Click to EnlargeAs displayed in the volatility chart provided courtesy of IVolatility.com, implied volatility (gold line) is still hovering close to 100%, while 30-day historical volatility (blue line) is down at 75%. It appears options have been persistently overpriced on MMR for the entire year, with the best opportunities coming for option sellers anytime implied volatility poked its head above the century mark.
Click to EnlargeGiven the cheap price tag and overall uptrend present in MMR’s stock price, selling put options may not be a bad way to go here. Traders could sell to open the August 11 strike puts for 55 cents or better. The max reward is limited to the original $55 credit received and will be captured if MMR remains above $11 by August expiration — a feat quite likely given MMR’s current bullish trend.
If the stock falls beneath $11, traders are obligated to buy 100 shares at a cost basis of $10.45 (the $11 strike price minus the original 55-cent credit received).
At the time of this writing Tyler Craig had no positions on MMR.