When Estimates Fail

• Posted by Adam Warner
• on October 23rd, 2009

Houston, we have our outlier. Amazon blew the doors off estimates (of course you can buy doors and Doors on Amazon). 

But as we all know, everybody blows away estimates. Amazon, unlike most other, blew away the options board as well. The board priced in something like a 7-9% move.

So what’s it all mean?

Well, just simple volatility can tell you the expected range on any given day, week, month, year, or any time frame. Except it’s not exactly a range, rather it’s a range within which we expect to see it fall 68% of the time. Let’s say we are looking at one day, and a stock (XYZ) with a volatility of 50. We can divide that volatility by the Square Root of the number of trading days per year (252) and convert it to a percentage (a little over 3%). That tells us that if volatility is fair, then XYZ will move under 3% about 2/3 of all days.

What about earnings day?

Well, the same principals should apply. We calculate the expected range a bit differently, as instead of straight volatility, we have to analyze it in terms of the expected change in volatility. And by doing that, we get a number in percentage terms that measures the expected magnitude of the move. And we can expect the underlying stock to move within that range about 2/3 of the time.

Of course that also means 1/3 of the time, it will move outside the range, often by a large amount. Like AMZN.

It doesn’t mean options “failed”. They’re supposed to fail sometimes. Selling options gamma in everything pre-earnings ultimately becomes a zero sum game, this is exactly why.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus