Friday, August 8, 2008

options and stock volatility

I picked up some Aug 20 calls last Thursday and Friday at 90 cents and 85 cents. Last week a $1-plus move in the underlying stock price was moving the options a lot more than today's paltry 10 cents. What gives? Usually the correlations don't deviate this quickly by my, admittedly, superficial observations. Hope to get some feedback.


TIA, without knowing the specifics of the stock, its price, the specific strike you owned or what prompted the $1 price move, it's hard for me to give a definitive explanation for why there was only a paltry move in the value of the calls, but my best guess is that you have been introduced to the concept of vega risk.

Vega is change in the price of an option relative to a change in the volatility of the underlying stock. In other words, it is the dollar measure of the impact of implied volatility.

The most often and predictable occurrences of a drastic decline in implied volatility, which would lead to a relative decline in options value, occur after a known news event. These events would include earnings, an impending court ruling or expected results or approval from the FDA on a drug in its trial stages. For a more in-depth look at how to calculate an expected price move, look at this article.

Leading up to these expected events, the implied volatility of the options will usually increase, sometimes dramatically, and then, once the news is released, regardless of the outcome, implied volatility will decline. Even though we are almost through the end of earnings season, remember the acronym of PEPC, or post-earnings premium crush.

Again, the other item to keep in mind is the strike price and its delta. This article discusses how to gauge an expected effect to the options from a change in volatility of the underlying security.
Learn About Options

By far, the most frequently asked questions are inquiries into educational resources. So as we head into the vacations days of the last two weeks of August, it makes sense to provide some reading material.

Aside from leaning on this past article that lists some of my favorite books and Web sites, I'll note something new. OptionsXpress (OXPS) redesigned its Web site, which enables prospective customers to test-drive all its tools and educational material for free for 10 days.

Visitors to the site can view videos and written content based on all products and across various levels of trading experience. Previously, these services, such as mock or paper trading and educational content, were available only to customers.


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