Blog: Solarfun (SOLF) - Call Purchases with Reverse Skew

Wednesday, January 6, 2010

Solarfun (SOLF) - Call Purchases with Reverse Skew

SOLF is a $260 million solar company in China. The LIVEVOL™ Pro Summary is below. Note that vol is up with stock up.

The company averages 1,485 option contracts a day - in the first 90 minutes over 16,000 have traded. The calls have traded 10:1 to puts. Further, the Net Deltas and Net Premium are substantially positive - indicating purchases of options and net long positions. The details are included below in the Company Tab snapshot (click the image to enlarge).

The Options Tab snapshot below (click to enlarge) demonstrates the most active trades. Jan 7.5, Jan 10, Feb 10 and Feb 12.5 calls. Note the Feb calls are opening. You can check the Time Sales Tab to see that these are purchases.

The Charts Tab snapshot below (click the image to enlarge) illustrates four things:
(1) The price increase of late.
(2) The implied vol increase of late - IV30™ (red line) vs HV30™ (blue line).
(3) The high level of option volume (height of volume bar) and
(4) The propensity of opening order customer call purchases (the green coloring).

Note this is a stock going up with vol also increasing. Volatility skew is the shape of the vol curve in a month going across strikes. Normally this is a downward smile (or smirk) - Lower strikes have higher vol than higher strikes. This is because the investing world (retail, mutual funds, pension funds) are generally long stock.

Implications:
(1) They buy puts for downside protection - raising the price (supply/demand) and therefore increasing the vol of lower strike price options.
(2) They sell upside calls for income on the long shares - lowering the price (supply/demand) and therefore decreasing vol of higher strike price options.

This relationship generally holds true. That's one reason why when stocks go down, vol goes up. i.e. stocks go down, people long stock buy puts for protection -> greater demand for options -> higher vol.

Similarly, that's why vol goes down when stocks move up. i.e. stock moves up -> longs stock sell OTM calls for income -> less demand for options -> lower vol.

But, for certain types of companies, the demand for upside calls is so great that the skew (vol) heads up for OTM calls as well - this is speculative call buying. Solar companies are a great example. Below you will see my make shift chart of SOLF skew versus IBM skew. The red circles draw your attention to the upside skew in SOLF unlike IBM.

The call buyers in SOLF are pushing up vol (and the skew). As market makers sell calls to customers, they keep raising the price to compensate for the piling on risk. The price goes up as they raise vol. Note that SOLF had an upgrade this morning to $13.

* UPDATE: 9-17-2010
With the new 3-D Skew Tab out in Livevol Pro, I have included a much better illustration of these same types of skews. The first chart is AAPL Skew, which is "normal" looking. The second is STEC on a day where call purchases have out paced puts on a 20:1 ratio pushing the upside skew.