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Minyan Mailbag - Option Pricing

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Professor Succo,

Option pricing question. I've been trading the Goldman Sachs (GS:NYSE) Sept 90 puts. Even though the stock is down nicely over the last three days, the im vols and the delta have dropped. The IV has gone from 23 to 17 even though the VXO is up and the delta has dropped from 54 yesterday when the stock was a buck higher to a current level of 46. What am I missing here? By comparison, my Lehman (LEH:NYSE) Sept 75 puts have been great over the time frame.

Thanks,
Minyan Hal


Minyan Hal,

This is typical and is called "riding down the skew". The calls have gone from in the money to out of the money. The skew dictates that out of the money calls trade at lower implied volatilities than in the money calls (although irrational in my opinion).

Without a volatile move in getting there (and the move has not been that volatile), the market makers who have been short these options have been able to re-hedge (sell stock) without much difficulty. They will not bid up the relative price of the options in an effort to "get out and cut losses". They are actually waiting for you to panic and sell them cheaply. This is the subjectivity (art) of trading options.

As long as you can capture the current price in volatility terms the best way to approach this is to wait for a move in a day (over 1.5% which equates to a 20% implied volatility move). The more moves like this, the more market makers will then want to "get out" and bid up the relative price.

Regards,
Prof. Succo

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