Investing basics
How earnings move stocks
Why a company can beat expectations and still fall, how options show the move the market expects, and why option prices often drop the morning after.
Wenlo EditorialHow we write our guides5 min read
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What an earnings report contains
Public companies in the US report results every quarter. The earnings release gives revenue (total sales), earnings per share (EPS, profit divided by the number of shares) and often a range of other figures such as margins, customer counts or units sold. The full quarterly report is filed with the SEC, and most companies also hold a conference call where executives answer analysts’ questions.
Many companies also give guidance: their own forecast for the next quarter or year. As you’ll see, guidance often matters as much as the results themselves.
Expectations matter more than results
Before each report, analysts publish estimates. The average of those estimates is the consensus. A stock’s price already reflects what investors broadly expect, so the reaction depends less on whether results were good and more on whether they were better or worse than expected.
- A beat means results came in above consensus; a miss means below.
- Investors sometimes have their own, unofficial expectations (a “whisper number”). A small beat can disappoint if people were hoping for a big one.
- Revenue, EPS, margins and guidance can point in different directions. The market tends to weigh whichever one says most about the future.
Example
A beat that falls
Suppose consensus expects EPS of $1.00 and the company reports $1.10, a 10% beat. Revenue is in line. But management lowers its forecast for next year, citing weaker orders. It is entirely possible for the stock to fall the next morning: the quarter that just ended is history, and the guidance changes what investors expect from now on.
Guidance and the conference call
Guidance is management’s best estimate of what comes next, so a change in it can move the price more than a few cents of EPS. Comments on the call, about demand, costs, pricing or competition, can shift the price again after the initial reaction. That is why a stock can jump in the first minutes after a release and end the next day somewhere quite different.
Results can also include one-off items, such as a legal settlement or the sale of a business, that make the headline number look better or worse than the underlying business. Companies often report an “adjusted” figure alongside the official one; reading what was adjusted is worth the time.
How big a move the market expects
You don’t need to trade options to learn from them. Option prices reflect how much movement traders expect, and before earnings that expectation usually rises sharply. That shows up as higher implied volatility (IV).
A common shortcut for the expected move is the price of an at-the-money straddle: one call and one put at the strike nearest the current price, both expiring soon after the report. The straddle pays off if the stock moves far enough in either direction, so its price is roughly the size of move traders are pricing in.
Example
Reading the expected move
Suppose a stock trades at $100, the report comes out tonight, and options expiring in 7 days are priced with IV of 80%. Using the Black-Scholes model with a 4% interest rate and no dividend, the $100 call plus the $100 put cost about $8.83 together. That suggests the market is pricing a move of roughly ±$8.83, or about ±8.8%, by expiration.
Comparing the actual move with the expected one is more informative than the move alone. A 5% drop is a big day for many stocks, but less surprising when options were pricing nearly 9%.
Why option prices often drop after earnings
Once the news is out, the uncertainty it carried is gone, and implied volatility usually falls quickly. People call this IV crush. It can make an option lose value even when the stock moves in the direction its buyer wanted.
Example
A move that wasn’t enough
Continuing the example: the next morning the stock is up 4% at $104, IV has dropped to 30%, and 6 days are left. The same $100 straddle is now worth about $4.67. Someone who bought it for $8.83 has lost about $4.16 a share, or $416 per contract (each covers 100 shares), even though the stock moved. The move was smaller than the one that was priced in.
The same effect works the other way for people who sold those options: they gain from the drop in IV, but they take on the risk that the stock moves much more than expected, and that loss can be large.
Timing: before the open, after the close
Most US companies report either before the market opens or after it closes, rarely during regular hours. The first reaction therefore happens in extended-hours trading, when fewer people trade and spreads are wider, and the stock often gaps: it opens well above or below the previous close.
Risk
Gaps can jump past your orders
Gaps matter for anyone holding through a report. A stop-loss order doesn’t protect you at the stop price when the stock opens far beyond it: it becomes a market order and fills at the next available price. Companies announce their report dates in advance, so check the calendar before you trade.
Ways people handle earnings
There is no single right approach, and none of these is a recommendation. Common choices include:
- Holding through it as a long-term owner, accepting that earnings days are part of owning a stock.
- Reducing position size before the report, so a surprise move hurts less.
- Waiting until after, to trade on what was reported instead of guessing.
- Looking at history: how far the stock has moved on past reports compared with what options priced in.
Whatever you choose, decide before the report, not in the first minutes after it, when prices move fastest and spreads are widest.