Wednesday, October 31, 2007

Implied Volatility (updated)

I've been continuing my research into options strategies. Earnings season is here again, which always causes a spike in implied volatility. GRMN released it's earnings this morning. Yesterday, the implied volatility of at the money calls were in the 80s and 90s. Today, they are in the 60s. I suspect they will continue to fall for a couple more days.

Implied volatility is the free-market version of statistical volatility. SI indicates how much the underlying stock actually fluctuates, while VI indicates how much people expect it to move. What's this mean for options? Before major events, like earnings releases, IV spikes, as do options prices. Thus, much of the movement people expect is already priced into the option. In general, right before earnings is a bad time to buy options. However, if you own shares in the underlying stock, writing covered call options is very good, or if you have cash on hand, you can make a quick 2-4% by writing cash secured puts.

Anyway, in my research, I found a great site for finding highly volatile options:

Here, you can specify a minimum stock price, minimum open interest, and a % out of money maximum something that I don't understand. I don't know exactly what all the filters in the Power Tools tab do, this one included, but I like sorting by the 'Call Implied' column. Unfortunately, the filter is confused by recently split stocks, where a $10 stock with a $20 strike will trade at $2 (the $20 strike option was written before the split, and the options trading house hasn't fully updated everything), so it looks like the $20 strike is trading abnormally high, when in actuality, you can't really trade it. It will also show a lot of $5 stocks with a $7.50 strike trading at $0.10. This isn't a high enough price to make much money writing options, sadly. To avoid the latter problem, I like to specify a minimum stock price of $6. Higher priced stocks have closer strike prices.

Using the sorted 'Call Implied' column, though, I've found HYTM. I don't quite know what to make of it, yet, but it's a $6.50 stock with a $7.50 November 2007 call option price of about $0.70. That means people are willing to pay a 10% premium betting on a 15% move in one month. Admittedly, HYTM's earnings is on November 5, so I don't know what the long-term IV is like. This may be a stock only worth writing options against this one time. Also, Google Finance's stock page for HYTM shows a news story where the state of Washington kicked out HYTM's drug rehabilitation cocktail because it didn't work. Collecting a 10% premium isn't a good idea if the underlying company goes broke.

Either way, I went ahead and bought 1200 shares and wrote 12 call options for $6.45 and $0.65, respectively. After commissions, I made about 9.7%, which I will fully realize on November 17. Then I'll be able to see how much a regular month's option is worth. I may end up bailing out after that time. Or, I may get my shares called away at $7.50, giving me a total profit of ~25%, instead. I can live with that.

Updated at 3:00pm

HYTM announced a double blind study, so the stock price shot up to $7.30 (+0.85 over purchase price), and DXUKU (Nov $7.5 calls) are now at $1.10. So, I missed out on some options premium profit, but at this rate, it's looking like that 25% profit on November 17 will be happening. I can still live with that.