What’s Tweaking The Premiums In Microsoft?

This morning’s downgrade of Microsoft
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by Goldman Sachs has kept the pressure up on the tech sector.
Volatilities in MSFT options are among the craziest we’ve seen in quite some
time. Now, we all know that a Bush presidency is expected to be less litigious
than a Gore presidency. Certainly Mr. Gore’s actions have borne out that
belief. In any case, the January options in MSFT are pumped up significantly and
will remain so until we finally have closure in the presidential race.

The near-term December options are trading up in the 93% range. January 2001
options fall back to a more reasonable 75%, but the January 2002 options are
trading for MSFT’s usual 53% level. Rarely do we see such disparity in the
modern options era.

In plain English, the January 2002 50 calls are trading for 13 3/4, which is
about a 53% volatility. The January 2001 50 calls are trading for 6 7/8, which
is that outrageous 75% volatility. If both options were trading under more
“normal” circumstances, we would expect the January 2001 50 calls to trade
for about $5, not 6 7/8. Thus, those able to sell the short-term January calls
are collecting an extra 1 7/8!

This overvaluation presents several opportunities. One would be a calendar or
‘time-spread’. Traders could buy the January 2002 50 call and
sell the January 2001 50 calls, thus buying time. Forty-four days from now,
those January 2001 50 calls will either be out-the-money, or in-the-money. In
either case, the volatility will begin to compress back to a more reasonable
level. The long January 2002 calls decay, but at a significantly slower pace
than the short-term January 2001 calls.

As I said, we rarely see such opportunities in today’s option marketplace, but
this one is jumping off our search engines.