GNTA high IV

[Hello_Dollars]

Quote from AngusP:

Been looking at some payoff's based on placing a ratio backspread on 27th April. Best compromise I can find is a 5:3 using the 15 and 20 strikes. Prices shown are based on eod - you may have done better by legging in during the day, or worse of course.

I think this shows the dilemma. Price on the news would have needed to get above about 35 to show an immediate profit on a break to the upside. Otherwise you are left waiting for expiry above 19.47, and although the initial break on FDA approval may have been up to 35+, whether it would have stayed there until expiry is of course open to conjecture.

Given the break to the downside, there would have been a profit on Friday below about $11, and therefore a loss at all prices between 11 and 35. In reality I guess it may have been worse than that because an announcement that resulted in little movement would have lead to a volatility crush which would have widened those limits, and also given a greater loss in the 15 - 20 area.

I think you're using the wrong strikes. When the stock was around 15, the play would've been to sell the ATM's and buy 2x (or more) of the 12.5's or 10's. You may want to try those and see if the results would've been different.

 

[MYDemaray]

Angus, if you run the analysis at these lower strikes, please post. I would love to see the results. Thanks.

 

[AngusP]

HD - I placed the long strike at 15 (ATM), which is where losses are maximised, on the basis that this was the price that GNTA was least likely to be at after the FDA announcement.

Turning to the 15/12.5 for a moment, you'd have needed to sell 3 and buy 4 if the backspread was to be placed for a credit. Again, I've used eod prices - better (or worse) prices may have been obtainable by legging in. There would have been no profit on the day the pre-announcement came out, and very little on announcement day - profit below $5.60 only.

 

[AngusP]

Now looking at the 15/10, this could have been placed for a credit on a 1:2 basis. But there would have been a small loss on Friday (pre-announcement) ..........

 

[AngusP]

......... and on Monday (announcement day) profit would have been minimal (below $5.70 only) due to the IV crush. And there is still the very high risk of significant loss in the event that price moved a smaller amount. So based on the payoff, no profit even on a halving in price, and only minimal profit on price falling by 66%.

These are tough trades to win!

 

[Hello_Dollars]

Quote from AngusP:

HD - I placed the long strike at 15 (ATM), which is where losses are maximised, on the basis that this was the price that GNTA was least likely to be at after the FDA announcement.

Turning to the 15/12.5 for a moment, you'd have needed to sell 3 and buy 4 if the backspread was to be placed for a credit. There would have been no profit on the day the pre-announcement came out, and very little on announcement day - profit below $5.60 only.

How about a 15/10 backspread? I'm sure that could've been done in at least a 1X2 ratio, and perhaps 1X3, while maintaining a credit. If the downside break-even would've been 7.50 or higher, the trade would've been successful according to Mav's thesis -- that the stock would either double or be cut in half on the news.

As I'm sure he'll acknowledge, if the expectation is for a more moderate reaction, than the play is simply not appropriate. It's to be used only on stocks where you have an expectation for a large move in the immediate future. Of course there are no guarantees that the market will cooperate with your expectation. But, after evaluating the strategy myself, it seems like a low-risk/high reward way to play these types of situations.

 

[AngusP]

Quote from Hello_Dollars:

How about a 15/10 backspread? I'm sure that could've been done in at least a 1X2 ratio, and perhaps 1X3, while maintaining a credit. If the downside break-even would've been 7.50 or higher, the trade would've been successful according to Mav's thesis -- that the stock would either double or be cut in half on the news.

As I'm sure he'll acknowledge, if the expectation is for a more moderate reaction, than the play is simply not appropriate. It's to be used only on stocks where you have an expectation for a large move in the immediate future. Of course there are no guarantees that the market will cooperate with your expectation. But, after evaluating the strategy myself, it seems like a low-risk/high reward way to play these types of situations.

HD - I think your last missive may have crossed with mine showing the 15/10 backspread. As I mentioned earlier - no criticism of Mav (or anyone else) intended - I just want to get a handle on these types of trade.

 

[Maverick74]

Angus,

Quick question for you. Where is the underlying on these trades? The time to put this spread on was when the stock was at 17, not at 8.50. The trade was over by then. I know the news didn't come out till Monday, but essentially the news was leaked. Putting the backspread on at between 8 and 9 is too late as the stock is already down 50% on the leak of the news.

So are you using the right underlying price?

Also, you never do a backspread for less then a 1 x 2 ratio. If you do, you don't have enough long gamma.

If you are expecting a moderate move then you would go with the short backspread instead of a long backspread. But normally on these FDA plays, you what what riskarb would call a 2 sigma event, many times 3 sigma event.

But your right, there is no free lunch in this business. Betting on FDA outcomes has the same odds as the blackjack tables. Something you should know before you place your bet.

Of course, I do pretty well at blackjack. LOL.

 

[Hello_Dollars]

Quote from AngusP:

HD - I think your last missive may have crossed with mine showing the 15/10 backspread. As I mentioned earlier - no criticism of Mav (or anyone else) intended - I just want to get a handle on these types of trade.

Angus, the graph doesn't look quite right to me. With virtually any ATM backspread done in a 1X2 or better ratio that I've ever looked at, the max loss would be minimal on any one day move (assuming there's more than a few days to expiry). The only thing that would alter that would be a very signinificant vol crush. So I'm assuming you've modeled one. However, I'm not sure that's a reasonable assumption in this case in light of the speed and magnitude of the real (and projected) price decline.

 

[AngusP]

Mav - underlying was at $14.43 (close on 27th April).

HD - looking at the figs, there was an IV crush on the longs, bought with IV of 290.8% and which fell to 256% after the announcement. The IV of the short 15's were sold at 286%, but is shown as 370% on Friday following the leak, and 0% on Monday which can't be right. I've run it in Hoadley and it would appear to be 183% so, not knowing how to change the IV in Optionetics I've done it in Hoadley.

The light blue line shows the payoff line on 27th April, and the thin red line the payoff on 3rd May - showing the effect of the IV crush. Whichever way you cut it you need the price below $6 to show a profit, and down around $4 if potential profit is to exceed the max loss with the stock above $10.

Quote from Maverick74:


Of course, I do pretty well at blackjack. LOL.

Yeah! I'll stick thanks.