Adjusting IV spike & Implied Move for time

[mks212 0]

I've been thinking about ways of refining our method for choosing trades. I know we look at IM and IV which makes perfect sense. However, there is a challenge because the same company doesn't always announce earnings at the same point in the expiration cycle.

When they are the week of expiration, the IV spike is much larger due to a very short time to expiration. When they announce further out, the IV spike might not appear on the charts we look at on optionistics, but the IM is also misleading because there is a lot of time value remaining.

Any ideas on how we can make an adjustment for this, so that we are always comparing apples to apples? I'm thinking this will require some sort of equation, so I am looking towards the more advanced mathematicians among us.

Thank you.

Mike

[Marco 221]

you're absolutely right. I don't even look at implied vol for weeklies anymore for that reason. I think its pretty meaningless and compares badly. Instead I just look at the implied move (IM). If the atm straddle did cost 5% in the previous cycle that will compare well vs. 4.5% this cycle for example even if last time the option had 6 days to expiry and this time say only 3. If you look at IV numbers for that example they will be different by 10's of points. So for weeklies just look at the IM for monthlies the IV will be much more comparable even if the expiry is a few days different (I would say up to 4 days difference on maturities of 20 days+ is still pretty comparable) . The premium as IM however becomes less useful (as it will account for a lot of time value after the earnings) Here they describe a methodology to calculate an IM for monthly options. It's far from perfect though and I wouldn't look at the outcome the same way as the price of the weekly atm straddle. Try it a few times for stock that have weekly options and compare the outcome vs. the weekly straddle to get an idea for how well it works (or doesn't).

 

 

[mks212 0]

Good points Marco. I wonder if the "best" way is to make sure to compare the ATM straddle at the close of the position to the ATM straddle when the position was opened. For example, if XYZ was at $100 5 days before expiration, and was $105 right before the announcement, compare the price of the $100 straddle 5 days out to the price of the $105 straddle right before the announcement. That will give a sense of gains from volatility. Gamma is separate from that, and while welcome, can't be relied upon.

[Marco 221]

I look at both. As you say one for the IM and one to see whether you frequently would have made gamma gains. I'm more happy to enter a stock though that consistently showed IM gains and/or where the current IM looks cheap vs. historical moves and previous IM's. As you say gamma is a bonus (that I'm happy to take however)

[mks212 0]

I look at both. As you say one for the IM and one to see whether you frequently would have made gamma gains. I'm more happy to enter a stock though that consistently showed IM gains and/or where the current IM looks cheap vs. historical moves and previous IM's. As you say gamma is a bonus (that I'm happy to take however)

Regarding Gamma gains, in Dec I actually went through the most volatile stocks I could find and then looked for earnings related IV spikes. My thought was if I can rent the options for very little, let me raise the odds of gamma gains. That hasn't really panned out though in this earnings cycle. The move needs to be rather large for it to make it worthwhile to roll the straddle. Also, the market has been quiet the past few months.

FOSL is a good example. I entered the 105 straddle, and the stock moved down to 101 I believe, and there was no money to be made by rolling. This stock is also affected by very wide bid/ask spreads on the options. I might avoid it going forward for this reason.

[Kim 7,502]

Thank you Marco, those are very good points.

 

The further you are from expiration, the less likely that you will have any gamma gains. This is why FOSL was no point to roll, the price was almost identical to the next strike.

[mks212 0]

The further you are from expiration, the less likely that you will have any gamma gains. This is why FOSL was no point to roll, the price was almost identical to the next strike.

That's a good insight Kim. I will keep it in mind. What about the bid/ask spread on FOSL? The trade went from a small loss to a larger-than-I-would-like-loss because I got filled on both sides far from the mid.

[samerh 6]

Following this thread and the main post on how to determine a good entry price for earnings, my question is do you ever also look at implied move in Standard Deviation terms to help determine a good entry price and not just % move? (The thinking being that that options prices are theoretically based on standard deviations rather than on % moves as referenced in Augen's various books).

 

For example, say we have stock with earning coming out and the straddle we want to trade gives an implied move of $3. Can we compare this to a 1 standard deviation move calculated using some IV from a period without earnings (eg prior month, forward IV from the link that Marco reference above, or the stock's IV) to see if the straddle is priced attractively? If the $3 would only equate to a 1 standard deviation move using this metric and the stock typically moves, say, 2.5 standard deviations following earnings then $3 would be a good price.

 

(Have spent most of the weekend going through SO posts but haven't seen a direct answer to this, forgive me if this has already been answered and I've missed it).

Edited June 24, 2013 by samerh

[Kim 7,502]

How looking at SD will give you more info than the IM? In your example:

 

"If the $3 would only equate to a 1 standard deviation move using this metric and the stock typically moves, say, 2.5 standard deviations following earnings then $3 would be a good price."

 

We would reach the same conclusion looking at the % IM.

[indiana*josh 59]

Yes, SD and %IM would give us the same conclusion with respect to a given stock.  I wonder if SD might give us a way to normalize and compare across stocks.  For example, if the straddle price represents a 1 SD move, and the average move over the past 4 quarters has been 2.5 SD, maybe we could say this position is available at an SOR (Steady Options Ratio) of 40% (1 / 2.5), which would make it a comparatively better buy than one being offered at a higher SOR (all else being equal).

[samerh 6]

I suppose the biggest difference is that a, say, 2.5SD move might equate to a 5% move in a low vol environment but 10% in a high vol environment and to my understanding, straddles are priced to protect against SD moves. It's been something I've been going around for a while and would be grateful for more clarity from those more experienced/ knowledgeable than me. I'm looking at historical prices on GMCR, GOOG, PCLN, NKE to see if implied SD correlates better or worse than implied % but is been slow going. Wondering if anyone else had done this?