Monday, May 3, 2010

Quest Diagnostics (DGX) - Screaming Upside Skew and a Spread

DGX is trading 56.69. The LIVEVOL™ Pro Summary is below.

Thanks to Michael Kenny, a blog reader, who found this one. I'll start with the Skew Tab snap (click to enlarge).

You can see extreme upside skew in the front three months - and in particular in the front (red).

The Options Tab illustrates the details.

You can see the May 65 calls are 0.25 bid with huge OI (long as far as I can tell) and keep getting bid up. The back months are reacting since the vol is so high in the front.

One thing to keep in mind is that you generally want to buy cheap vol and sell expensive vol - so how about this trade:

Buy 1 May 60 call for $0.50
Sell 1 May 65 call @ $0.25

That's $0.25 for a $5 call spread with growing OI and upside skew. The May 60 calls are hardly "cheap", but at least the spread buys lower vol than it sells.

Keep in mind, this has a max gain of $4.75 and max loss of $0.25... which means, there is a very low likelihood of success. With the 19:1 maxprofit:maxloss payout, fair value would indicate the odds of hitting max loss are 1:19. Just keep that in mind - this is "probably" a losing trade. If you think the odds are higher than 1:19 to hit max gain, then there is edge.

Also note, DGX had earnings recently and were down on them.

This is trade analysis, not a recommendation.

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