For contrarian traders looking to short Thursday’s explosive price move in NFLX, two bearish trades had dramatically different success as the price of the underlying declined into the afternoon. As is often the case, you can learn a lot just by watching and analyzing the sequence of events in autopsies of the trades.
In order to set the stage, NFLX closed on Wednesday at $107 and the implied volatility (IV) of the front month at-the-money puts and calls averaged 57%. Options of NFLX are very liquid and were trading with reasonable BA spreads.
By 10:30 AM, NFLX price had risen dramatically to $117.46. For the trader who wished to take a contrarian view, he could have purchased the out-of-the-money May 115 puts, the then at-the-money strike for $4.95. Importantly, the IV was 84%. Another trader who prefers to sell premium, could have sold the slightly out-of-the-money calls, the May 120 strike, for $5 at an IV of 84%.
At 2:00 PM the stock had sold off to $113.96. How did our two traders fare? The put buyer could have sold his position for $5.60 for a net profit of 65¢ on the initial position. The premium seller would have been able to close his call position for $2.70 for a gain of $2.30. Both positions were closed at an IV of around 71%.
What is the explanation for the disparity in the results? The reason is volatility crush. Both positions were initiated at an IV of 84% and closed at an IV of 71%. However the call sale represented a vega negative trade while the put buy was a vega positive trade. Volatility had
exploded upwards with the dramatic and sudden price rise.
Although IV is generally considered to be inversely related to price, it is important to realize that it can also spike with dramatic and rapid price rises. The outcomes of these two different trades emphasize the importance of considering IV as well as price when designing option trades.