Monday, December 22, 2008

IV Implosion

I just assume that very few people would read my little blog randomly. After all, I'm not well-known, don't advertise and am not an extremely frequent poster of commentary. However, I'm sure it would help the random reader to have some point of reference for a few of the phrases I use from time to time during my one weekly feature, the earnings look-ahead.

One of the considerations that often pops up is implied volatility, particularly in reference to historic volatility. At this point, I am assuming some basic familiarity with options and the different parameters (delta, theta, etc.) affecting the price. I wrote this little bit below over a year ago but it still holds true and illustrates the concept of IV implosion quite well. The specific date of the event noted below escapes me at this point but it is nearly irrelevant anyway.
AMLN watchers had been anticipating exenatide LAR results for a long time and consequently had driven IV up to around 80 (maybe higher), in turn inflating the value of both calls and puts. When the data was finally released on Wednesday morning, the stock tumbled about 3%. Obviously, the call options would be affected. But look at this chart:

The puts lost nearly 50% of their value also, even as they went in the money. Of course, there's a lot more math involved but this is the best illustration of just how IV implosion works when it comes to highly anticipated events like data release in biotech and earnings calls.

Unfortunately, I can't remember what day this was so I can't find the share pricing graph to match up with the options pricing. But as stated before, it's largely irrelevant to the illustration.