Jan 4, 2018

Traders Are Sur­pris­ing­ly Slow to Respond to Off-hours Earn­ings Announcements

It can take days for investors to react, cre­at­ing a poten­tial­ly lucra­tive strat­e­gy for some.

Lisa Röper

Based on the research of

Matthew R. Lyle

Christopher Rigsby

Andrew Stephen

Teri Lombardi Yohn

On Wall Street, busi­ness hours” aren’t quite what they seem. 

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The open­ing bell of the New York Stock Exchange rings at 9:30 a.m. East­ern, and the clos­ing bell sounds at 4 in the after­noon — yet 95 per­cent of pub­licly trad­ed com­pa­nies announce their quar­ter­ly earn­ings out­side of those offi­cial hours.

So how do traders respond to off-hour announcements? 

I have three kids,” says Matt Lyle, an assis­tant pro­fes­sor of account­ing and infor­ma­tion man­age­ment at the Kel­logg School. And there are times when I’m with my kids and, if I get an email that’s impor­tant for work, I can’t real­ly con­cen­trate on it until I’m not dis­tract­ed by oth­er things.” 

Lyle won­dered whether the same was true for traders try­ing to process earn­ings infor­ma­tion. In a new study, Lyle and coau­thors indeed find that the tim­ing of earn­ings announce­ments has a strong impact on how investors incor­po­rate them into their invest­ment decisions. 

Specif­i­cal­ly, the fur­ther from busi­ness hours earn­ings are announced, the slow­er the investors’ reac­tion, par­tic­u­lar­ly for announce­ments made before the open­ing bell. This delay is not a mere mat­ter of hours. To the authors’ sur­prise, it takes a full four days for investors to ful­ly inte­grate the new infor­ma­tion into their port­fo­lios when it is announced ear­ly in the morning. 

This puz­zling result could prove lucra­tive for investors: the authors find that options traders stand to turn a steady prof­it if they incor­po­rate these results into their trad­ing strategies. 

The Tim­ing of Earn­ings Announce­ments Mat­ters

Lyle and his col­leagues — Kel­logg doc­tor­al stu­dent Christo­pher Rigs­by, Andrew Stephan of the Uni­ver­si­ty of Col­orado, and Teri Lom­bar­di Yohn of Indi­ana Uni­ver­si­ty — start­ed by explor­ing how investors respond­ed to ear­ly morn­ing ver­sus evening announcements. 

Oth­er research has shown that when investors are dis­tract­ed — on Fri­days, on days with lots of oth­er earn­ings announce­ments, or dur­ing March Mad­ness, for instance — they are slow to react to impor­tant finan­cial information. 

With that in mind, Lyle and his coau­thors hypoth­e­sized that traders would respond more quick­ly to post-close announce­ments (those released between 4 p.m. and mid­night East­ern) than to pre-open announce­ments (those released between mid­night and 9:30 a.m.). Their think­ing: since many traders (espe­cial­ly those in fur­ther-west time zones) are still at work when the mar­ket clos­es, they would more like­ly have time to read and think about the announce­ment before after-work activ­i­ties and fam­i­ly oblig­a­tions took over. For the same rea­son, the authors sus­pect­ed that the clos­er to busi­ness hours a com­pa­ny announced earn­ings, the quick­er investors would react. 

The researchers pro­cured a dataset from an invest­ment-research firm con­tain­ing a large sam­ple of quar­ter­ly earn­ings announce­ments from 2006 to 2014, each time-stamped down to the sec­ond. They sort­ed them into two cat­e­gories: pre-open” and post-close.”

Part of research is to doc­u­ment things that do not con­form with the way we think the world works.”

To mea­sure investor response, the researchers focused on volatil­i­ty. When­ev­er a com­pa­ny releas­es its quar­ter­ly earn­ings, there is a cer­tain amount of extra fluc­tu­a­tion in its stock’s per­for­mance, as traders buy or sell based on the new infor­ma­tion. By mea­sur­ing how long this volatil­i­ty lin­gered after an announce­ment, the researchers could esti­mate how quick­ly investors reacted.

Their research con­firmed their hunch — stock prices sta­bi­lized faster after a post-close announce­ment than after a pre-open announce­ment. Addi­tion­al­ly, the fur­ther from NYSE hours an announce­ment came, morn­ing or evening, the longer its stock remained in flux. 

To Lyle, this sug­gest­ed that investors need­ed extra time to con­sid­er and act on intel they received out­side of work hours. 

But he could not yet be sure — there was anoth­er poten­tial expla­na­tion the researchers still need­ed to account for. 

Maybe firms mak­ing ear­ly morn­ing announce­ments were also more like­ly to have some­thing to hide, the authors the­o­rized. If so, this dif­fer­ence in volatil­i­ty could be a reflec­tion of what was in the announce­ments, rather than the time of day. (And in fact, con­ven­tion­al wis­dom says that firms with bad news will make their announce­ments late at night, or on a Fri­day, to lessen the impact on their stock.) 

But con­trary to this wis­dom, the team found that firms were high­ly con­sis­tent in when they made their announcements. 

For instance,” Lyle says, Apple announces at 4:30, with­in thir­ty min­utes of the clos­ing bell, at the same time basi­cal­ly every time. GE announces at 6:30 in the morn­ing, basi­cal­ly all the time. So while there’s no doubt that the firms do play a lit­tle bit of strate­gic games, it’s very hard to attribute our results to that.” 

The authors ran sta­tis­ti­cal tests, which con­firmed that noth­ing in the con­tent of the earn­ings announce­ments could account for dif­fer­ences in stock volatil­i­ty. Nor could char­ac­ter­is­tics of the firms, like its size, prof­itabil­i­ty, or time zone. The best expla­na­tion was the timing. 

The Lag Lingers

Still, in an envi­ron­ment where com­put­ers can trade stocks in nanosec­onds, how long could this added volatil­i­ty linger? The researchers pre­dict­ed that, even when announce­ments were made off-hours, investors would like­ly take at most a few hours to respond to them. 

That is not what we find,” Lyle says. 

When they com­pared how stocks were far­ing a full day after earn­ings announce­ments, they found that com­pa­nies that announced pre-open were still fluc­tu­at­ing more than post-close announc­ers. Many investors, it seemed, were just get­ting around to the incon­ve­nient­ly timed earn­ings report a day later. 

The researchers looked fur­ther and fur­ther out. Two days after the ini­tial announce­ment, the gap in volatil­i­ty per­sist­ed. Three days after, the same sto­ry. It took a full four days before pre-open stock prices had sta­bi­lized as much as post-close stock prices. 

This con­firmed the team’s hypoth­e­sis that reac­tions to ear­ly morn­ing announce­ments would be delayed. But why were they delayed for a full four days? Lyle is still not sure. 

I mean, it’s shock­ing!” he says. It’s hard to gen­er­ate a the­o­ry that will lead to this type of pre­dic­tion. Which is also one of the rea­sons why we think the study’s impor­tant — part of research is to doc­u­ment things that do not con­form with the way we think the world works.” 

A Lucra­tive Find­ing

Although Lyle was shocked by this find­ing, he sus­pect­ed there was one group of folks who might not be: options traders. 

We said, Giv­en that options traders care so much about volatil­i­ty, if anyone’s gonna know about this result, it would prob­a­bly be the options mar­ket,’” he says. 

Options are finan­cial instru­ments that traders can use to spec­u­late on the per­for­mance of stocks. If an investor buys an option, she is essen­tial­ly bet­ting that a company’s stock will hit a cer­tain price with­in a giv­en time peri­od. The more a stock’s price fluc­tu­ates, the high­er the odds that it will hit that giv­en stock price in any time peri­od, and so the high­er price that option will be. 

If options traders indeed already knew that com­pa­nies that announced earn­ings in the morn­ing tend­ed to expe­ri­ence more pro­longed volatil­i­ty, then options prices should adjust accordingly. 

And if that was the case, then they couldn’t make mon­ey off of it,” Lyle explains. 

The authors devised two trad­ing strate­gies that would prof­it when pre-open com­pa­nies’ stock prices fluc­tu­at­ed more than post-close com­pa­nies’ stock prices. They used a data­base of options prices and stock per­for­mance to mod­el how these strate­gies would have per­formed had they been applied to real trades in the past. 

Sur­pris­ing­ly, the strate­gies deliv­ered large and sig­nif­i­cant returns — which indi­cat­ed that the options mar­ket was not, in fact, aware of this quirk. 

Hav­ing suc­ceed­ed on paper, these strate­gies are now being test­ed in the real mar­ket­place. Lyle shared his results with a pair of North­west­ern alum­ni he knows who work as traders. So far, they have inde­pen­dent­ly con­firmed Lyle’s results and are cur­rent­ly devis­ing for­mal trad­ing strate­gies to earn traders a profit. 

Shift­ing Pat­terns

The study’s unex­pect­ed results have left Lyle want­i­ng to look more close­ly at a relat­ed issue: why firms choose to announce earn­ings when they do. 

Once upon a time, many announce­ments hap­pened dur­ing the busi­ness day. But by the late 1990s, after-hours announce­ments had become com­mon­place. Ana­lysts have offered com­pet­ing the­o­ries about what brought about this change. Some sus­pect it had to do with new finan­cial-dis­clo­sure leg­is­la­tion, while oth­ers tie it to the advent of elec­tron­ic trading. 

Nobody’s been able to give us a clear answer,” Lyle says. I think it’s quite curi­ous. And maybe under­stand­ing that will also help us bet­ter under­stand the results that we’ve doc­u­ment­ed now.”

Featured Faculty

Matthew R. Lyle

Associate Professor of Accounting Information & Management

About the Writer

Jake J. Smith is a writer and radio producer in Chicago.

About the Research

Lyle, Matthew R., Christopher Rigsby, Andrew Stephen, and Teri Lombardi Yohn. 2017. “The Timing of Earnings Announcements and Volatility.” Working paper.

Read the original

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