Impact of future events on volatilities (ie. awaiting FDA approval etc.)

[thecoder]

This is just a hypothetical case:

Suppose for a biotech company the current ATM implied volatility (IV) for both Call and Put options is about 30%. On Dec 7 (ie. in about 4 months from now) the FDA will decide whether an important drug product of this company will get approval or not.
How should the IVs of the monthly options for Sep, Oct, Nov, Dec, Jan, Feb realistically be, as seen from now? Which month should have the highest IV as of now (I guess the Nov and/or Dec options). How should the IVs of Jan and Feb be as of now?

 

[alphadistribution]

IV will likely be highest on the options expiring immediately following the singular volatility event. So Dec 18 on a monthly or on an earlier weekly option if available.

Earlier expirations will not include the event so their IV will be lower and later expirations will spread the singular event IV over longer “regular” behavior of the underlying.

 

[thecoder]

IV will likely be highest on the options expiring immediately following the singular volatility event. So Dec 18 on a monthly or on an earlier weekly option if available.

Earlier expirations will not include the event so their IV will be lower and later expirations will spread the singular event IV over longer “regular” behavior of the underlying.

Thx, makes sense.
I just wonder which mathematical probability distribution one should use to model such an IV curve:
https://en.wikipedia.org/wiki/List_of_probability_distributions

 

[Atikon]

Thx, makes sense.
I just wonder which mathematical probability distribution one should use to model such an IV curve:
https://en.wikipedia.org/wiki/List_of_probability_distributions

I had the same question ones, IV blows up atm and your wings stay roughly the same/below the atm IV. It's like a binary option/event. IV is derived from the price, so ppl are going to bid up the options until it reaches the Expected Value of the Event on the Call and Put Side Strikes (in an efficient market). It's an upside down Volatility Curve, with OTM Strikes showing lower IV than the ATM Strikes

In a nutshell how Cornwall capital made it's seed money.

 

[thecoder]

@Atikon, do you mean the volatility smile one normally sees now flattens, or even turns around, when the event approaches?

 

[Atikon]

@Atikon, do you mean the volatility smile one normally sees now flattens, or even turns around, when the event approaches?

Should turn around/reverse as soon as the info is out there, if not, the option is underpriced and you have a great opportunity in front of you

 

[thecoder]

With such events I think there are 5 phases:

Phase 1: normal phase, date of event is announced/known, IV remains say 30%
Phase 2: starts about 4 weeks before the event and lasts about 3 weeks: IV rises gradually to high values, f.e. 90%
Phase 3: the last week before the event: IV rises further, f.e. to 150% or even higher
Phase 4: the week after the event: IV falls "linearly" to normal levels
Phase 5: normal phase continues

Some years ago I had made such an experience with SRPT. I unfortunately don't remember the details, but in general I think the above scheme was playing.

 

[Atikon]

Yeah mate i don't think anyone is going to wait for the next option, they will just discount the theta decay and bid up the t0 options available, which will cover the event. The ones that will be created after that acc to the same pricing, but since they are closer to the event= less that's decay= less discount + some gamma premium

 

[thecoder]

I was the option writer then, with just 10k initial investment and reinvesting daily the profits made, made a total profit of 28k in only 4 weeks.
Unfortunately the same strategy failed the next time in a similar case, leading to a big loss of about 15k :-(
Those were the days, my friend...

 

[Atikon]

I was the option writer then, with just 10k initial investment and reinvesting daily the profits made, made a total profit of 28k in only 4 weeks.
Unfortunately the same strategy failed the next time in a similar case, leading to a big loss of about 15k :-(

Yeah, there are plenty of old threads here where ppl that are in this game 10-30 years saying exactly that. Options, in general, are fairly priced. One move like in 87 will take back all your gains. The less liquid/the less eyes on a stock, the more likely a mispricing will happen. I wouldn't sell options on a stock where the volume is less than 2 mill. shares p. d. Also I wouldn't sell high IV Rank blindly without researching the stocks fundamentals. In general you should expect a reason for a person being willing to bid up an options to a price where IV is extraordinary high. It may be hype, but there are enough papers out there that proof the opposite.