MSFT & AMZN - UPDATE: Earnings Vol and Skew "Pair Trade"

MSFT is trading 29.11; AMZN is trading 129.56 after earnings. Both had earnings yesterday AMC. The LIVEVOL™ Pro Summaries are below.





You can see the obligatory vol crushes after earnings. The blog from yesterday setting up the pair trade is available HERE.

The Skew charts from yesterday (pre-earnings) and today (post-earnings) are included below (click any image to enlarge it).

Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month









So what was the hypothetical winning pair trade yesterday?

Version 1
Assume we wanted to be contract neutral
(1) Sell 1 Front AMZN ATM (125) straddle --> Collect 14.75
(2) Buy 1 Front MSFT ATM (29) straddle ---> Pay 2.29

Today:
(1) Buy 1 AMZN straddle back ---> Pay 10.10
(1) Sell 1 MSFT straddle back ---> Collect 1.45

PnL = (14.75 - 10.10) + (1.45 - 2.29) = $3.81 (i.e. make $381 for each pair of straddles).

But the risk yesterday could have also been seen as a vol (vega) risk.
Version 2
Assume we wanted to be vol neutral
(1) Sell 1 Front AMZN ATM (125) straddle ---> Collect 14.75: get short ~120 vol points
(2) Buy 1.5 Front MSFT ATM (29) straddle ---> Pay 2.29: get long ~ 120 vol points

Today:
(1) Buy 1 AMZN straddle back ---> Pay 10.10
(1) Sell 1.5 MSFT straddle back ---> Collect 1.45

PnL = (14.75 - 10.10) + 1.5*(1.45 - 2.29) = $3.39 (i.e. make $339 for each pair of straddles).

That's the winning trade. Note that this is a $130 stock vs a $29 stock so a vega hedge would be a much more proper trade. I have left this step to the reader but ultimatley it means more MSFT to AMZN.

If you follow the belief that the vol was spiking do to dual phenomenon (link in prior blog) and watched the AAPL vol crush - you might have been lead to do this trade. Of course, finding the right trade after the fact is pretty easy...

You can see from the skew charts (before and after) that the AMZN straddle was the better sale relative to MSFT without going through the whole trade analysis as well. Just look at the dip in the AMZN red line (front month) relative to MSFT above.

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MSFT & AMZN - Earnings Vol and Skew "Correlation"

MSFT is trading 29.07; AMZN is trading 124.74. Both have earnings today AMC. The LIVEVOL™ Pro Summaries are below.





Note that MSFT IV30™ is 35 vs short term HV measures (10,20,30) all in the 20's. Similarly, AMZN IV30™ is 55 vs short term HV measures (10,20,30) in the high 20 range. Of course, this is simply an expression of earnings vol - since the day of earnings represents a high volatility event.

The Charts Tab snapshot for each (click either image to enlarge) is included below.





The upper portion of the charts are the underlying; the lower portion is a chart of IV30™ (red line) vs HV20 (blue line).

MSFT: We can see graphically the divergence noted above betwen IV30™ and HV20. Further you can see that the level of IV30™ for MSFT is higher than it's been over the last six months - well above the level of last earnings. Also note that MSFT gapped after last earnings, the IV30™ was a purchase but the stock rip didn't blow past the implied move very far.

AMZN: Again we can see graphically the divergence noted above betwen IV30™ and HV20. Also you can see that the level ov IV30™ for AMZN is higher than it's been over the last six months - well above the level of last earnings. But - last earnings the underlying gap was so large, the IV30™ was a purchase into earnings. Note how the blue ine (HV20) gaps well past the IV30™ (red line).

For both stocks, there is a reason for the heightened vol even relative to prior earnings. For a discussion of the "dual" phenomenon, please go HERE.

The Earnings and Dividends Tabs for each stock are included below. Click either image to enlarge. MSFT on top, AMZN on the bottom.





What you're looking at:
(1) The top row is the stock price 5 trading days before earnings through 5 trading days after.
(2) The middle row is the front two month ATM straddles for the same horizon.
(3) The bottom row is the front two month ATM straddle vols for the time horizon.

MSFT: You can clearly see the vol crush (drop) after earnings in MSFT (as expected). You can note that the straddles decreased in value after earnings (they were sales) for the 4/23 and 7/23 cycles. The 10/23 cylce shows the the straddles went up (they were a purchase).

AMZN: Pretty much the same observations. Note however that the last cycle (10/22) the straddles exploded because the stock ripped.

Finally, the Skew Charts for each are included below. You can see the skew for each today (just before earnings) and the skew on 1/7/2010 - "normal" skew. Click any chart to enlarge.









Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month

For both stocks we can see the front month (red) bursting forward as earnings approach. This is expected behavior. For a quick discussion why this happens you can go HERE.

So all this analysis shows us that MSFT and AMZN have behaved similarly over the last 3 earnings cycles and are behaving similarly into this one...

When this type of relationship develops, often times traders on the floor look to make "correlation" bets (or "pair trades"); for example buy one vega and sell the other. Note the term "correlation" is used loosely here - I have not presented a linear measure of relationship. This is all very "touchy-feely" - not really rigorous.

Since the positions offset - the positions are naturally hedged (if they go in the same direction). If a trader is able to pick which vega is a better purchase relative to the other, they can scalp while being hedged. Obviously a ton of other risks are involved - but this is one way we think about it on the floor. Whether or not it's a trading opportunity I leave to you.

Questions to ask yourself: Is there any reason to believe one vol is a better purchase than another? If not, maybe this is simply a "pass on the trade." If yes, maybe not... Are there any other things you could look at other than vol? Are the relative vols similar in divergence?

This is not advice - it is just analysis.

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AAPL Vol & Skew Update Number #2

AAPL is trading 209.82. The LIVEVOL™ Pro Summary is below.



Pre-earnings Vol Blog: HERE

Post-earnings Vol Blog: HERE

The news is out on the iPad and its pricing; the news is out on earnings as well. I have included the skew pre-earnings (with market dipping), post earnings and now after the iPad news. I find this progression an interesting study in the movement of the months relative to each other and the skew shape with impending news; I hope you do too. Click any image to enlarge it; note the movement of the front month(s) (red and yellow).

Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month







As a volatility event approaches (earnings, news, etc) the month it occurs in naturally rises higher than others. It's simple math really - here's a contrived but illustrative example.

Say a stock has normal vol of 20 on a standard day. Say a vol event (FDA decision for a drug or earnings, or whatever) has a vol level of 150.

Say there are 10 days to front expo and the vol event is in five days. Then the front month vol will be an average of:

Front: 20, 20, 20, 20, 150, 20, 20, 20 ,20 20

Second: Front + 20, 20, 20, 20, ..... for 22 days.

Third: Front + Second + 20, 20, 20....

So they vol event is "diluted" by fewer "standard vol days" (20 in this case) in the closest month.

Technical detail: Note the term average is used loosely here as you cannot average standard deviations - you must square , then average then square root.

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Toyota (TM) - Effects on Vol and Skew of News

TM is trading 80.52 down more than $6. The IV30™ is up 21%. The LIVEVOL™ Pro Summary is below.



The news, of course, is this:

From Seeking Alpha (a great newsletter fyi)
In an unprecedented move, Toyota (TM) has halted U.S. production and sales of eight models, including its top-selling Camry and Corolla models, on mounting concerns that defects might cause the cars to accelerate unintentionally. The eight models represented 57% of Toyota's 2009 sales. A Toyota spokesman didn't specify how long the sales suspension will last, but the move will no doubt be costly both in terms of lost revenue and damage to a once-strong reputation for safety.

The company has traded over 6,000 options today in the first 45 minutes on total daily average option volume of 981. The Company Tab snapshot is below (click the image to enlarge).



The Option Tab snapshot is inlcuded below (click the image to enlarge).



You can see the downside puts are trading on greater volume than open interest (OI) - these are opening trades. These trades are pushing up the volatility on those strikes and therefore bending the skew relative to normal. The skew chart for today and as of 11/20/2009 are included below (click either image to enlarge).

Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month
Dark Blue - Fifth Month
Purple - Sixth Month





Note that on 11/20/2009 the months stacked on top of each other pretty well. The downside skew was "normal shaped" with a slight upward turn to the downside. To read details about why option skew exists the reader is directed to the blog "Understanding Option Skew" available by clicking HERE.

The skew chart as of today shows a distinct separation of the months on the downside - with the front month (red) considerably higher than the other months. This indicates higher perceived risk in the short term - read "uncertainty".


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Tempur Pedic (TPX) - Update on Straddle Sale

TPX is trading 24.40. The LIVEVOL™ Pro Summary is below.



You can read the first blog: HERE.

The straddles were sold @ 3.90 originally. Here is the image of the old trades (click to enlarge): You can also the ale was 56 vol.



Now the fair value of the straddles is ~0.725 + 1.40 = 2.125. You can see the Options Tab snapshot below (click to enlarge): The gain so far is 100*3800*($3.90-$2.125) = $674,500.




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Barnes and Noble (BKS) - Front Month Skew

BKS is trading 19.70 with IV30™ up 34%. The LIVEVOL™ Pro Summary is below.



The company is trading up on news of a deal with AAPL and the tablet and vol is going up. This is just a quick note to notice the pronounced skew in the front (red) relative to other months. Click either image below to enlarge - self explanatory I hope.






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Salix Pharma (SLXP) - Vol and Skew Comps into FDA Decision with Strangles

SLXP is trading 28.74 with IV30™ up slightly. The LIVEVOL™ Pro Summary is below.



The company has traded over 10,500 options today in the first 2 hours on total daily average option volume of 1,133. The Company Tab snapshot is below (click the image to enlarge).



The bulk of the volume has been a 4,000 lot purchase of Mar 22.5/35 strangles (buy 35 calls, buy 22.5 puts) for 2.20. The day's biggest trades and Option Tab snapshots are inlcuded below (click either image to enlarge).





Note the trade sizes are significantly larger than the open interest - these are opening trades. Note also the Mar vol relative to Feb. The news is this:

From Briefing.com:
The firm [read: Wedbush] notes that with an advisory panel now on the schedule for February 23 and several channel checks confirming their thought that the FDA more wants to discuss Hepatic Encephalopathy, in general, as opposed to any specific issue or safety concerns with Xifaxan, they see as lower risk going into the meeting. Additionally, the firm thinks the feedback from the FDA on the content and format of the NDA package for IBS-D and a confirmed timeframe there of a submission targeted for the first half of 2010 is an incremental positive for the co.

So The vol event is in the March cycle as expo for Feb options is Feb. 19 (four days before the announcement).

The Skew Tab snapshot illustrates some interesting phenomenon. Click the image to enlarge it.



First, we can easily see the vol difference between the front month (red) and the other months (yellow is March). Second, and more interesting, you can see a relatively flat skew. This is somewhat unusual. The very generic thought process going into small pharma/bio tech decisions is that the ATM vol is a purchase and the OTM vol is a sale - obviously it's not that easy - that was not advice, just analysis.

In this case, the OTM vol (the edges of the graph) are pretty flat. For reference, I have included the BA (Boeing) skew chart. You can see how pronounced BA downside skew is going into earnings. Essentially, the skew shows that BA has greater downside risk relative to ATM vol than the small pharma with an FDA panel meeting coming up. Again, that's a RELATIVE comparison. Absolute vol is much lower in BA. Click the image to enlarge it.



The Charts Tab illustrates that SLXP can move substantially on news and when it does, the IV "would have been" a purchase. In the chart on the bottom half of the tab, the IV30™ is the red line, the HV30™ is the blue. Note how high the HV30™ got with that big move near September of last year relative to IV30™ now.



With the large strangle purchase, it looks like someone does feel that the OTM options are too cheap - and they showed it with a 4,000 x 100 x $2.20 = $880,000 bet.


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AAPL Earnings Vol & Skew Update

AAPL is trading 205.91. The LIVEVOL™ Pro Summary is below. Note the vol crush in IV30™.



A quick update on the last AAPL blog (yesterday pre-earnings). Click to read the original vol and skew post: CLICK HERE.

I have posted the skew today - after earnings and re-posted the skew yesterday. Note the drop in the red (front month) vol relative to the other months as well as the yellow (second month).

Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month

Click either image to enlarge.





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Fifth Third (FITB) - Front Call Buyer into New Highs

FITB is trading 12.41. The LIVEVOL™ Pro Summary is below. Note the falling IV30™. This issue was brought up to me by broker extraordinaire Mike Bristow with VTBrokers.



The company has traded over 41,500 options today in the first few hours on total daily average option volume of 10,119. Further, 38,000 + have been calls for a 10:1 call:put ratio. The Company Tab snapshot is below (click the image to enlarge).



10,500 Feb 14 calls have been traded and 14,500 May 14 calls traded as well. Feb 12.5/14 1x3 Call spread traded 3000 x 9000 at 8 cents and crossed on the PHLX (sell 14 buy 12.5). The day's biggest trades and Option Tab snapshots (Feb and May) are inlcuded below (click either image to enlarge).







Note the low open interest relative to trade size in the Feb 14 and May 14 calls - these are opening trades. Finally the Charts Tab snapshot is presented below. You can see the stock is hitting new recent highs off of a bounce from earnings. 52 wk. high is 12.87.



The PnL for the 1 x 3 call spread is inlcuded below.



Max Gain with stock at $14.
Break Even Low: 12.58
Break Even High: 14.71

This is bullish with a limit. The naked call purchases in May are obviously bullish unless they traded with stock.

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Apple (AAPL) - Earnings Vol and Skew

AAPL is trading 202.07. The LIVEVOL™ Pro Summary is below. Note the IV30™ drop today and that earnings are today AMC.



The Charts Tab snapshots are included below from Friday (6 mos) and then for today (6 mos) respectively. Click any of the images to enlarge.





For the chart from Friday you can see the exploding IV30™ (red line) relative to the HV30™ (blue line). Also note the IV30™ increase last earnings and the subsequent fall with a gap up in stock price.

The chart from today adds one more data point (today). Note the sell off in vol before earnings.

IV tends upward into earnings as that one specific day has greater vol than others. IV has a tendency to rise as the market falls as well - so AAPL vol was exploding on two phenomenon - (1) earnings and (2) market drop. You can see the level of IV30™ even after the vol drop today is well above anything over the last 6 months (including another earnings cycle). It seems the vol increase may have been over bought, as AAPL vol is lowering pre-earnings.

Finally, you can see that AAPL has a pronounced reverse skew - the calls are bid as high as the puts. For a thorough discussion of "normal" skew shape please read this post: HERE.

The 3D skew chart (animated) is included below (this is a rough copy - the real movie is smoother). This Skew chart is coming to Livevol™ Pro soon and is patent pending.

******************* CLICK THIS IMAGE TO ANIMATE IT


Note the highest strike calls and how high the vol is relative to the other months.
Skew legend:
Red - Front Month
Yellow - Second Month
Green - Third Month
Light Blue - Fourth Month
Dark Blue - Fifth Month
Purple - Sixth Month

This means Feb calls are expensive relative to March.

You can also check out the vol levels last earnings date (pre-earnings - 10/19/2009). Click the image to enlarge.



Then see how the vols looked the day after earnings. Click the image to enlarge.



And finally, how the vol looks today. Click the image to enlarge.



Note the vol crush from pre to after earnings in the front month (red) which is as expected. Note also the higher level of vol this time (dual phenomenon discussion above). The vol crush could be substantial in this cycle - of course, the higher vol implies greater potential for stock movement.

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