Brian Johnson - Exploiting Earnings Volatility: An Innovative New Approach to Evaluating, Optimizing, and Trading Option Strategies to Profit from Earnings Announcements

Brian Johnson, a professionalinvestment manager with many years of trading and teaching experience, wrotehis first book, Option Strategy Risk / Return Ratios: A Revolutionary NewApproach to Optimizing, Adjusting, and Trading Any Option Income Strategy in2014. It has been one of the top-selling option books and it has receivedoutstanding reviews by the option trading community.

His new book, Exploiting Earnings Volatility,introduces an innovative new framework for evaluating, optimizing, and tradingoption strategies to profit from earnings-related pricing anomalies. Leveraginghis extensive background in option-pricing and decades of experience ininvestment management and trading, Brian Johnson developed this inventiveapproach specifically to design and manage option earnings strategies.

These revolutionary new tools can be applied to any option earningsstrategy on any underlying security. In an Active Trader article titledModeling Implied Volatility, Mr. Johnson introduced a formula for aggregatingdiscrete volatility measures into a single metric that can be used withconventional option pricing formulas to accurately model implied volatilitybefore and after earnings announcements. The practical application of thisformula has profound implications for option trading and strategy development.

Exploiting Earnings Volatility is written in a clear,understandable fashion and explains how to use this revolutionary approach to1) solve for the expected level of earnings volatility implicitly priced in anoption matrix, 2) calculate historical levels of realized and implied earningsvolatility, 3) develop strategies to exploit divergences between the two, and4) calculate expected future levels of implied volatility before and afterearnings announcements.

Furthermore, Exploiting Earnings Volatility also includestwo Excel spreadsheets. The Basic spreadsheet employs minimal input data toestimate current and historical earnings volatility and utilizes thoseestimates to forecast future levels of implied volatility around earningsannouncements.

The Integrated spreadsheet includes a comprehensivevolatility model that simultaneously integrates and quantifies every componentof real-world implied volatility, including earnings volatility. This powerfultool allows the reader to identify the precise level of over or undervaluationof every option in the matrix and to accurately forecast future option pricesand option strategy profits and losses before and after earnings announcements.

The Integrated spreadsheet even includes an optimizationtool designed to identify the option strategy with the highest level of returnper unit of risk, based on the users specific assumptions.

Written specifically for investors who have familiarity withoptions, this practical guide begins with a detailed review of volatility, thesingle most important (and often misunderstood) component of option pricing. Theaggregate implied volatility formula is fully explained in Chapter 2, whichalso includes graphical examples to communicate the mathematical relationshipsvisually and intuitively.

Chapter 3 includes a detailed step-by-step guide to usingthe Basic spreadsheet to calculate historical and implied levels of earningsvolatility and to forecast future levels of implied volatility before and afterearnings announcements.

The next chapter provides a conceptual and mathematicalexplanation of True Greeks, accurate measures of risk and return sensitivitythat reflect the real-world behavior of options. New option Greeks that arespecific to earnings announcements are also introduced in this chapter. TheIntegrated spreadsheet calculates True Greek values for individual optionsand for option strategies.

Building on the above foundation, Chapter 5 includes a tradeexample that uses actual market data and analytical results from bothspreadsheets to design a unique option strategy to exploit earnings-relatedpricing and volatility anomalies.

After illustrating the capabilities of the spreadsheets in areal-world trade example, Chapters 6 through 8 explain every module of the Integratedspreadsheet tool and how to best use this spreadsheet in practice: how toimport the data, enter user specifications, solve for volatility parameters, andoptimize and evaluate option strategies. The data for a single underlyingsecurity and its option matrix with actual prices are used in both spreadsheetsand throughout these chapters to demonstrate the process traders would employin a real-world environment.

The next chapter includes another real-world trading examplewith actual market data, which illustrates how the analytical tools in thisbook can be used in different market environments. The final chapter examinespractical considerations and prospective applications of these innovative newtools.

This book introduces a new analytical framework that maysound complicated at first, but is really quite intuitive. Formulas areprovided to ensure an accurate mathematical description of the analyticalframework. The formulas presented in the book are limited to basic high-school algebra,so they should be accessible to most readers. However, for those readers who stillhave nightmares about high-school algebra, important mathematical relationshipsare also explained intuitively and depicted graphically.

Most important, you will not need to perform any of thesecalculations manually. Exploiting Earnings Volatility includes alink to Excel spreadsheets that perform all of the calculations described inthe book. In addition, the Integrated spreadsheet functions are all automatedand accessible via
push-button macros.

All of the formulas in the book are presented in Excelformat to make it easier for readers who would like to experiment with thesetools in their own Excel spreadsheets.

The unique price and volatility behaviorof options before and after discrete earnings announcements is an enigma tomost option traders, even to many professional option traders. The aggregatevolatility formula is relatively simple, but it has profound implications. Whenintegrated with a real-world volatility model, it offers unparalleled insightsinto earnings volatility, price behavior, option strategy construction, andprospective value-added opportunities.