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M70-301 MB6-869 1Z0-144 1Z0-599 400-051 70-458 810-420 C_TBW45_70 C2090-540 C2180-276 C4090-452 EX0-001 HP2-E59 PEGACSSA_v6.2 1Z0-061 220-801 640-911 70-680 C_TSCM52_66 ICBB 070-331 312-50v8 820-421 C_TAW12_731 JN0-102 70-483 70-488 700-505 70-347 070-347 070-411 70-486 MB2-701 070-346 100-101 70-346 70-463 700-501 70-412 C4090-958 EX200 070-463 70-331 70-457 HP0-J73 070-412 C_TFIN52_66 070-489 070-687 1Z0-062 350-029 070-247 070-467 1Z0-485 640-864 70-465 70-687 74-325 74-343 98-372 C2180-278 C4040-221 C4040-225 70-243 70-480 C_TAW12_731 C_HANATEC131 C2090-303 070-243 070-417 1Z0-060 70-460 70-487 M70-301 MB6-869 1Z0-144 1Z0-599 400-051 70-458 810-420 C_TBW45_70 C2090-540 C2180-276 C4090-452 EX0-001 HP2-E59 PEGACSSA_v6.2 1Z0-061 220-801 640-911 70-680 C_TSCM52_66 MB2-701 070-346 100-101 70-346 70-463 700-501 70-412 C4090-958 EX200 070-463 70-331 70-457 HP0-J73 070-412 74-335 C_HANATEC131 C2090-303 070-243 070-417 1Z0-060 70-460 70-487 M70-301 MB6-869 1Z0-144 1Z0-599 400-051 70-458 810-420 C_TBW45_70 C2090-540 C2180-276 C4090-452 EX0-001

November 2, 2010

Reading Tea Leaves

It is often a daunting task deciphering the tremendous amount of information contained within an option chain for the trader beginning his study of the world of options. One of the most nuanced variables embedded within the prices quoted for the chains is that of the relative values of implied volatility (IV) amongst the various strike prices and the various months of expiration.

The IV of each of the various available options for a given underlying is not usually constant for each individual strike price and expiration cycle. The IV can and often does vary between individual strike prices within the same cycle; this variation is termed vertical skew. In addition, IV often varies at the same exact strike price when considered between various expiration cycles; this variation is termed a horizontal skew.

To review briefly, remember that option prices depend largely on the three primal forces of time to expiration, price of the underlying, and IV. The only one of these factors not immediately accessible to anyone with a quote screen and a calendar is IV. It is by changes in the magnitude of IV that future events of potential major import to the price of the underlying are expressed.

As an example of the information that can be gained by considering apparent anomalous values for IV, consider the case of ITMN. This biotech stock is represented in upcoming expiration cycles of: November, December, January, and April. Considering the example of the 14 strike call, the IV for these various months are: 54, 65, 78, and 136 respectively.

I have no idea what is up in the first quarter of 2011 for this stock, but the options markets are pricing a substantial probability of a significant price move between January and April expirations. These types of IV spikes are typically seen in biotech stocks ahead of significant FDA decisions.

Bill Burton, Market Taker Mentoring LLC