Obama Care - Why it Matters to Options, How Vols Explode While Industry Correlation to Market Moves Toward Zero

--- OVERVIEW --
AET is trading $42.93, down 0.7% with IV30™ up 4.8%.

CI is trading $44.81, down 0.1% with IV30™ up 2.6%.

UNH is trading $57.92, down 0.1% with IV30™ up 7.7%.

WLP is trading $69.10, up small with IV30™ up 8.9%.

The LIVEVOL® Pro Summaries for all four are included below, respectively.









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This a note on the Supreme Court Ruling due out soon on what has been called Obamacare, and some incredible (and recent) vol moves that have been rather "silent." Further, we'll see stocks rising as vol also rises and an industry that shows a vol correlation to the market that's moving lower. Before we get into stock prices and vols, I've inlcuded some fairly long snippets to discuss what Obamacare really is. Please note the source.

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1. Patients Cannot Be Dropped

The first change that will immediately take place is that health insurance companies will no longer end or refuse to renew coverage unless you have misrepresented yourself or your medical situation, or if fraud has been committed.

Likewise, your coverage cannot be dropped suddenly for reasons you may not be aware of. The health car bill mandates the removal of pre-existing condition clauses from all health insurance plans by 2014

2. Immunization and Preventive Care Must Be Covered

Another change is a section of the bill that requires all health insurance companies and all health insurance plans to cover both immunizations and preventive care.

3. Dependents Can be Covered Until Age 26

A third change has to do with dependents. It used to be that unmarried children could be covered under a parent’s health insurance plan until the age of 23.

4. Everyone is Required to Pay for Health Insurance?

The last notable change that goes into affect immediately has to do with limits. Health insurance companies can no longer put an annual or lifetime limit on a health care plan that is not reasonable. A limit is an amount of money predetermined by the insurance company.

Once an individual reaches this limit, they have to pay all other medical expenses out of pocket. This practice was put into place by insurance companies due to the rise of cancer. What is considered reasonable will be based on income, family size, and past usage of medical benefits.

What changes will occur in the long run?

There are many more changes that will go into affect over the next 5 years due to Obama Care. The most significant change for the average American is the removal of pre-existing conditions. For years, pre-existing conditions have caused millions of Americans to be without adequate coverage for diseases. Obama Care requires the removal of pre-existing clauses from all health insurance plans by 2014.

Another significant change is that Americans who do not obtain minimal health insurance coverage by the year 2014 will have to pay a penalty of $95. This penalty will rise every few years.

Source: InsuranceProviders.com; What is Obama Care?
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The Supreme Court now has to rule on the constitutionality of the law. There is a question as to whether or not the entire bill will be thrown out if there is in fact a ruling against it. In other words, there seem to be three potential outcomes: (1) Entire law goes into effect (2) Entire law does not go into effect (3) A part of the law goes into effect.

To make the issue more complicated, there are several different types of insurance providers. This note will focus on the "Managed Care Providers." And, what is "managed care?" I've pasted wikipedia's definition, below:

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The term managed care or managed health care is used in the United States to describe a variety of techniques intended to reduce the cost of providing health benefits and improve the quality of care ("managed care techniques") for organizations that use those techniques or provide them as services to other organizations ("managed care organization" or "MCO"), or to describe systems of financing and delivering health care to enrollees organized around managed care techniques and concepts ("managed care delivery systems"). According to the United States National Library of Medicine, the term "managed care" encompasses programs:

...intended to reduce unnecessary health care costs through a variety of mechanisms, including: economic incentives for physicians and patients to select less costly forms of care; programs for reviewing the medical necessity of specific services; increased beneficiary cost sharing; controls on inpatient admissions and lengths of stay; the establishment of cost-sharing incentives for outpatient surgery; selective contracting with health care providers; and the intensive management of high-cost health care cases. The programs may be provided in a variety of settings, such as Health Maintenance Organizations and Preferred Provider Organizations.[1]

Source: WIKIPEDIA; Managed care
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And finally, some news today regarding health insurers as the nation awaits the Supreme Court's ruling:

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NEW YORK (TheStreet) -- Investors will soon realize not all health care stocks are equal as the Supreme Court prepares to decide Obamacare's fate.

The good is for companies like Aetna(AET), Cigna(CI) and Coventry(CVH), which profit across the three major segments of Medicare, Medicaid and commercial health insurance. The bad is for the Medicaid HMOs like Amerigroup(AGP), Molina(MOH) and Centene(CNC).

"The companies that would be worst affected if the law were thrown out entirely ... you'd expect probably the Medicaid players, which would be Molina, Amerigroup, Centene, to fare poorly, given that they were hoping to take advantage of Medicaid expansion, which almost certainly wouldn't be resurrected if the law were thrown out," said Matthew Coffina, senior health care analyst at Morningstar.

Some estimates have found that between 16 million to 20 million new Americans would be eligible to enroll in Medicaid if the Supreme Court upholds Obamacare.

Obamacare as a whole gets thrown out, Medicaid HMOs would lose a large revenue opportunity they had expected to begin in 2014.

Medicaid enrollment would rise in 2014 because the law stipulated a shift in income eligibility; simply, the government would extend its low-income health insurance program to earners with a higher annual income than what is currently allowed.

[...]

"So that's not currently in their earnings -- they're not going to benefit today in their actions -- but come 2014 it would be a tailwind to revenue growth and profit," said Chris Rigg, senior health care analyst at Susquehanna Financial Group. "In the investment community there's a discounted value of that future revenue stream in the share prices today, and that discounted value goes away ... if health reform is overturned."

Source: TheStreet.com via Yahoo! Finance; Health Care Poised to Weather Obamacare's Fate, written by Joe Deaux.
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--- ANALYSIS --
OK, so here's the info needed to understand (a little) what's going on. Let's talk stock and vol and start with the AET Charts Tab (six months), below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).



I notice two trends worth observing:

1. AET stock has risen recently. On 5-18-2012, the stock closed at $39.23. As of this writing the stock is up exactly $3, or 9.4%. In that same time period, the S&P 500 is up just 2.4%.

2. The implied has been rising abruptly and is now well above both the short-term and long-term historical realized measures. Since that 5-18-2012 date, the IV30™ in AET is up 10.16 vol points or 31.3%. In that same period the IV30™ in the SPY has gone down 17.7%.

I've included the vol charts (six months) for CI, UNH and WLP, respectively, below.







We can see a very similar movement in the implied and for all three (four) of these names, we can see that the implied is well above the historical realized vol measures. In terms of the stock price movements, those also are quite similar. I've included a summary of vol and stock movements for all four companies along with the SPY for comparison purposes.



In English, the vols of these managed care companies have been exploding since 5-1-2012 (and 5-18-2012), while the stock prices have been rising. In that same time period, the vol for the overall market (SPY) is down significantly. This is a wonderful example of two phenomena that make option trading so interesting:

1. When vol rises, it doesn't mean that stock is dropping.
2. When industry specific news overhangs an entire industry, the correlation to the overall market (in terms of vol and / or stock) becomes almost meaningless.

Finally, let's turn to the Skew Tabs for the four managed care companies, below.









--- SUMMARY --
The skews are also quite similar with the second month (Jul) elevated to the third (Sep or Oct). The option market reflects greater risk in the near-term due to the volatility event that is the Supreme Court ruling. Note that the third month in each of these skews is not a ho-hum lazy Summer month. We're talking about Sep and Oct, so the elevated vol is non-trivial. As a relative measure, the SPY shows Jul vol of 19.05% while both Sep and Oct are priced over 21%. Again, the vol correlation in an entire industry (not just a single stock) moves closer to zero as an impactful industry event approaches.

Finally, I've included the first to second month vol diff in percentage (not vol points) terms, below, to identify which of these four companies have option prices that reflect the greatest change in risk from Jun to Jul.



Note that AET shows the highest Jun and Jul vol, reflecting the greatest risk overall of these four companies. Not surprisingly (given the vol), AET has also shown the largest price change since 5-18-2012 and the second largest vol increase since 5-1-2012. Having said that, a holistic view does give off of perspective that these four companies are essentially all in the same boat.

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