If you sell options, you’re probably familiar with the concept of the Implied Volatility (IV) ramp. As an earnings event approaches, implied volatility tends to climb, peaking right before the company reports.
Most traders think they understand why this happens, but the math behind it is often misunderstood. Today, we’re breaking down what the IV ramp actually is, how to find mispriced opportunities, and how you can use a long-volatility strategy to build a cheap—or even free—hedge for your short-volatility portfolio.
What is the IV Ramp? (The Math Might Surprise You)
The common misconception is that implied volatility rises because traders suddenly get panicked or excited as earnings approach. While emotion plays a small role, the primary driver is actually pure math.
Think of the implied volatility displayed on your brokerage platform as an average of two types of days:
Normal trading days (low volatility)
The earnings day (high volatility)
The Math Analogy:
Imagine you have a set of 10 numbers. Nine of them are small (normal days) and one is massive (earnings day). If you calculate the average, it will be heavily weighted by the nine small numbers.
Now, as time ticks forward and you get closer to earnings, those normal days drop off the calendar. You are slowly removing the small numbers from your data set. What happens to the average? It naturally goes up.
So, the IV ramp isn't always a sign of increasing fear; it’s often just the mathematical concentration of the earnings event itself.
The Strategy: Buying Pre-Earnings Straddles
If the IV ramp is just an averaging effect, is there still a trade here? Absolutely.
Instead of looking at general IV, we look at the implied move of the earnings event itself. If we can find opportunities where the market is pricing in a lower-than-average implied move a few weeks before the event, we have a massive edge.
The Mechanics of the Trade
The Setup: Buy an at-the-money (ATM) straddle (buying both a call and a put at the current stock price) 2 to 3 weeks before the earnings announcement.
The Goal: The increase in the implied move as the event approaches will cause the value of our options to rise. This expansion in volatility offsets the losses we incur from Theta (time decay).
The Hidden Upside: Because the volatility expansion covers our time decay costs, we get exposure to black swan events, massive market sell-offs, unexpected rallies, or buyout rumors practically for free.
How to Screen for the Best Setups
You shouldn’t blindly buy straddles on every stock. To find the highest-probability setups, look for a combination of specific criteria using an options scanner (like Predicting Alpha):
1. The Right Timeline
Look for tickers with confirmed earnings dates coming up in the next 2 to 3 weeks.
2. Deep Disconnected Value
Compare the current implied earnings move to the historical average earnings move. You want to see cases where the current implied move is significantly lower than usual.
3. Healthy Liquidity
Only trade tickers with tight bid-ask spreads to ensure you aren't giving away your edge to slippage and transaction costs.
Real-World Examples: 3 Trades Placed Today
To illustrate this, let’s look at three specific trades added to a pre-earnings long-volatility portfolio today: Rivan (RIVN), Matador Petroleum (MTDR), and PBF Energy (PBF).
Ticker | Current Implied Move | Historical Avg. Move | Context / Analysis |
RIVN | 11.0% | 14.0% | Deeply discounted compared to past performance. |
MTDR | 4.5% | ~8.0% | Volatility is at historic lows going into this event; expecting at least a 25% increase in the implied move level. |
PBF | 5.33% | ~8.0% | Great risk-to-reward ratio based on historical baselines. |
Case Study: TJX Companies (TJX)
Looking at the analysis for TJX, it reports earnings in about a month. Currently, the market is pricing in an implied move of 3.6%, which is 21% lower than its usual average of 3.56% realized volatility.
Looking at historical charts, these levels always form "valleys" in between earnings and "peaks" right at the event. Buying at the bottom of the valley allows us to ride the wave back up.
Managing the Position: Delta Hedging
We aren't buying these straddles to gamble on whether the stock goes up or down. To extract the pure volatility edge, use Gamma scalping.
This means hedging your Delta daily (buying or selling shares of the underlying stock to bring your total Delta back to zero). By doing this, you lock in the daily micro-movements of the stock, allowing you to monetize the difference between realized and implied volatility on a day-to-day basis.
Conclusion: The Perfect Short-Vol Portfolio Complement
If you are primarily an option seller, your portfolio is inherently vulnerable to massive market shocks.
By trading a basket of these mispriced pre-earnings straddles, you create a structural counterweight. If the market stays quiet, the rising IV allows you to break even. But if a stock suddenly gaps 10% or 15% pre-earnings, your long-volatility position will explode in value, effectively acting as a free hedge for the rest of your portfolio.
Have you ever traded the pre-earnings IV ramp? What strategies do you use to hedge your short volatility positions? Let us know in the comments below!