9 Weeks to Better Options Trading: An Options Pricing Primer
Veteran options trader Steve Smith breaks down the concepts of implied volatility and time decay.
A notable exception would be in biotechs such as Dendreon (NASDAQ:DNDN) or Biogen (NASDAQ:BIIB). Shares of these names can trade rather benignly for months on end, while the prospect of volatility-inducing events, like FDA rulings, keeps implied volatility at elevated levels. And more related to our current events, options on banks like JPMorgan (NYSE:JPM) and Bank of America (NYSE:BAC) have implied volatilities that are premiums to historic levels because of ongoing worries over exposure to Europe and other issues.
Let’s look at the April at-the-money calls in two very different types of stocks. Salesforce.com (NYSE:CRM), a high-octane momentum stock which regularly makes massive price swings, has a current 30-day historical implied volatility (HV) of 38%. On the other hand, the relatively staid and less-exciting utility Consolidated Edison (NYSE:ED) currently has a 30-day HV of 11%. But which one’s options are cheaper?
Salesforce.com is the obvious answer, but to be sure, let’s look under the hood at implied volatility readings. Salesforce.com’s April $135 call has an implied volatility of 35%, carrying a three-percentage-point, or 5.7% discount to HV. On the other hand, Con Ed’s April $57.50 calls carry a 12.5% implied volatility, which is a 1.5-percentage-point, or 14% premium to HV. So at this point, I would say Salesforce.com’s options, which trade at a discount, are cheaper than Con Ed’s, which trade at a premium.
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.