Forecasting earnings with volatility
- Implied volatility in Stoke Therapeutics (STOK) jumped in past 5 days
- Options market forecasting 61% earnings-day price move
- Historical data highlights spread between forecasts and reality
Biopharma company Stoke Therapeutics (STOK) was one of only seven symbols on Wednesday’s LiveAction scan listing the biggest implied volatility (IV) increases over the past five days—moves of at least 40 points.
While IV can help determine whether options prices may be relatively high or low, many traders take note of unusual IV levels because of what they can signal about a stock’s price action. At its most basic, IV is the options market’s forecast of how much a stock will move in the future—the more uncertainty, the higher IV will be.
As it turns out, STOK was one of two stocks on yesterday’s scan scheduled to release earnings on November 8 (next Tuesday). Not only had STOK’s IV increased significantly, the following profile shows the options market was anticipating the stock to make an exceptionally big move on earnings day (61%):
Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)
Rather than discuss why that forecast may be so high, let’s take a closer look at what this chart is really telling us. First, IV-based forecasts are an estimate of how much a stock may move—not whether that movement will be up or down.
Second, the purple dashed line, which is the average of all the past forecasts represented by the purple columns (16.52%), is nearly six times higher than the average actual earnings day move of 2.77% (yellow dashed line). In other words, the options market has typically overestimated how much STOK would move on earnings day.
That’s not to say the stock hasn’t occasionally made a big post-earnings move. The green and red columns that represent the actual up and down moves, respectively, on earnings day, have ranged from +26% to -11.7%. But out of the seven previous times since November 2019 a forecast was available, there was only one instance the stock’s move on earnings day was bigger than the estimate.
The following price chart highlights that instance—STOK’s 26% jump after its August 8 announcement—along with the much more modest moves after its two previous earnings releases:
Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)
Could STOK meet or exceed the options market’s estimate of its price move next Tuesday? Of course. It’s worthwhile to pay attention to any indication of unusual behavior in the market. But that doesn’t change the reality that STOK’s earnings moves have, more often than not, been smaller than estimated. Options volatility can provide useful insights into market behavior, but like any other tool, it has limitations and benefits from the proper context.
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