Most Traders Wait for Earnings Season to Sell Premium. The Data Says They're Waiting for Nothing.

Key Concepts

• Sector ETF Correlation: The statistical relationship between different sector-based Exchange Traded Funds.
• IVR (Implied Volatility Rank): A metric used to determine if current implied volatility is high or low relative to the past year.
• 16 Delta Strangle: An options strategy involving the simultaneous sale of an out-of-the-money put and an out-of-the-money call, typically at the 16 delta level.
• VIX (CBOE Volatility Index): A measure of the market's expectation of volatility based on S&P 500 index options.
• Cross-correlation: A measure of how closely the price movements of different assets (or their holdings) track one another.
• Theoretical Success Threshold: The statistical probability of an options trade expiring profitably based on historical data.

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1. Sector ETF Correlation and Trading Strategy

The research team analyzed the performance and correlation of heavily traded sector ETFs and their top five constituent holdings.

• Correlation Findings: Sector ETFs exhibit low to moderate long-term correlations, meaning they move in the same direction less than 50% of the time. This provides effective diversification for multi-sector portfolios.
• Utilities Exception: The Utilities sector (XLU) shows weaker relationships with other sectors, attributed to its high sensitivity to interest rates and its role in defensive allocation strategies.
• Constituent Holdings: The top five holdings within each ETF show an average cross-correlation of 0.27. This suggests that while these holdings drive the ETF, there is enough variance to justify holding the basket rather than individual stocks if one seeks to mitigate single-stock risk.
• Strategic Application: When individual stock IVRs are low, trading sector ETFs becomes a superior alternative. The study found that 16 delta strangles in these ETFs perform comparably to those in the SPY (S&P 500 ETF).

2. Earnings Season and VIX Sensitivity

The research team investigated whether the VIX experiences an "inflation" or significant spike during earnings seasons compared to non-earnings periods.

• The Myth: It is a common assumption that the VIX should be higher during earnings season due to the increased volatility of individual stocks.
• The Reality: The data shows that the VIX is largely indifferent to earnings seasons.
  • Statistical Evidence: The VIX made a new high 26 times during earnings seasons versus 24 times during non-earnings seasons—a negligible difference.
  • Structural Reason: The VIX is priced based on the SPY. Because the SPY is a broad basket of many products, the heightened volatility of a few individual stocks during earnings is "diluted" by the rest of the index, preventing a significant move in the VIX.
• Actionable Insight: Traders should not wait for earnings season to sell premium in ETFs, as there is no systematic "boost" in implied volatility for the index. Conversely, individual stocks do see significant volatility spikes during earnings, making them the appropriate target for volatility-based strategies.

3. Key Takeaways and Conclusions

• Diversification: Sector ETFs remain a reliable tool for diversification due to their low-to-moderate correlation.
• Strategy Selection: For strangle performance, sector selection based on volatility pricing is less critical than focusing on sector fundamentals. Selling 16 delta strangles across these sectors is a statistically sound approach that yields results comparable to the broader market (SPY).
• Myth Debunked: There is no meaningful correlation between index-level implied volatility (VIX) and individual stock implied volatility during earnings. The average VIX remains consistent regardless of whether it is earnings season or not.

"If you're planning on waiting for a boost in the VIX to sell premium in an ETF, don't wait for earnings season. It's not going to boost it." — Market Measures Research Summary