The 6-Week Options Trading Kickstarter: Options Pricing Basics
Steve Smith breaks down the basics of options pricing.
Fusion IO, ahead of its April 24 earnings report, saw implied volatility climb up to 90%, which was well above the 52% rate at which the 30-day HV was running at this time. This was because the options market was pricing in the 10% price move that the shares had averaged over the past four earnings reports. The stock responded to the earnings with a 7% decline to $26.20. Immediately following the report, IV declined to 55%, or right back to the HV.
This type of drop in implied volatility is quite common following an earnings report or any scheduled event that has market moving implications. In this case, the combination of the options having overpriced the expected move and the post-earnings premium crush means that the value of puts did not go up much despite the drop in stock price. For example, the May $25 puts only gained $0.20 to $1.80 on the day after the earnings report.
An increase in implied volatility ahead of an event is simply the expression of a higher probability of a larger-than-usual price move within a given time frame. In this sense, an increase in implied volatility is an artificial expansion of time. In other words, what could happen over a long period of time is now being priced into a shorter period of time, and that makes sense ahead of a volatility-inducing earnings report.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter