Declining Volatilites
We
have the great pleasure of having Len Yates fill in today in for Tony
Saliba and Jon Najarian. Thanks, Len.
As
I write this, the Nasdaq is having a quiet day after rising three days in a row,
something it hasn’t done in months. This,
together with it having broken a triangular “flag†to the upside, tells me
the short-term trend might be up. Chips,
box makers, and telecoms all seem to have completed a base and have turned up.
If
you’re buying calls, pick your stocks carefully, watching the implied
volatility (IV). They’re bringing
IV’s down in steps now. However,
they’re not doing it evenly! For
example, as of Thursday, Jan 11, IV had already come down in
(
EMC |
Quote |
Chart |
News |
PowerRating) and
(
BRCD |
Quote |
Chart |
News |
PowerRating),
but not in
(
SEBL |
Quote |
Chart |
News |
PowerRating) nor
(
JNPR |
Quote |
Chart |
News |
PowerRating). So
be careful you don’t buy expensive options just before they drop the IV, or
else you may be frustrated seeing your stock move up nicely but the calls not
change much.
The
effect can be larger than you think. To
illustrate, they apparently dropped JNPR’s nearby options IV from 130%
yesterday to 118% today. That made the
nearby at-the-money calls drop from 12 1/4 to 9 5/8, and the nearby puts drop
from 9 1/8 to 8 1/2. (The stock dropped a
couple of points too.) So a little drop
in IV causes a significant drop in option prices!
And
that may only be the beginning. There is
room for IV’s to drop a lot further. Witness
the historical volatility chart for SEBL, for example.
You
might think that buying farther-out options would help mitigate the effect of
declining IV’s, but in fact, because the farther-out options are more
expensive, small drops in IV have a big effect on them, too.
Rather
than outright buying options, you might consider doing your directional trading
using spreads, especially credit spreads. That
way you neutralize, and even place in your favor, the effect of declining
IV’s.