Options that are correlated to stock movement

davewolfs · Jul 13, 2009

I've read that during certain circumstances that an increase in stock price can reduce the value of a call option because of a reduction in volatility.

With that said, is the above statement something that happens to the majority of options when the market is in a specific phase in this case say a bull and trending or are these types of occurrences usually specific to the stock itself.

What I am getting at is if there is some sort of tool that would allow me to find highly liquid options whos prices move very closely with the stock prices (I could be wrong, but for this case to occur would implied volatility need to remain somewhat constant).

I appreciate any input.

Thanks!

MTE · Jul 13, 2009

I suggest you read a book or two on options. This will give you a better idea of how they behave.

The case where you correctly predict the direction of the price move, but still lose money due to volatility crush is more of a specific situation whereby the volatility gets bid up prior to some announcement, such as earnings, FDA hearing or other significant event, and then gets crushed on the announcement. Obviously, this happens all the time, but for general market moves, the volatility doesn't have such a dramatic impact, although it may and will still affect the option.

To minimize the impact of volatility you would trade the deep ITM options with 0.8 and higher delta. The downside to these is that they are relatively less liquid and thus have wider bid-spreads.

nazzdack · Jul 13, 2009

Quote from davewolfs:
.....some sort of tool that would allow me to find highly liquid options.....

Focus on larger-cap stocks and indices that are less affected by volatility movements than smaller-cap issues that have more "hot money" going in and out of them and where reports have more impact on the issue.

nitro · Jul 13, 2009

Quote from davewolfs:

...
What I am getting at is if there is some sort of tool that would allow me to find highly liquid options whos prices move very closely with the stock prices (I could be wrong, but for this case to occur would implied volatility need to remain somewhat constant)...

Shhhhhhh, it's a secret, it's called delta.

OddTrader · Jul 13, 2009

Quote from davewolfs:

What I am getting at is if there is some sort of tool that would allow me to find highly liquid options whos prices move very closely with the stock prices (... implied volatility need to remain somewhat constant).

I don't think the option or tool would exists.

davewolfs · Jul 13, 2009

Just to add, the strategy that I wanted to test out is basically finding options for a stock after it has had an unusual price price spike i.e. more then x standard deviations which has caused the call option price to plummet. This would only apply during trend phases of the market i.e. a clear bull or bear.

Say for example in a bull a pretty stable stock experiences this price spike which causes calls to become underpriced, I would buy (enter with trend) at say a failed double top and as the price would rise and volatility would move back to normal the price of the call would increase at a rate more then that of the stock.

I know this strategy sounds simple, and assuming that the stock does go in the direction that I am hoping for i.e. it continues to trend, is there any reason why my option would not also move back to prices that would be considered normal levels.

I know this strategy sounds simple but with trend trades usually work out pretty well, my only concern would be if the option started moving in the opposite direction.

mike007 · Jul 13, 2009

Quote from davewolfs:

Just to add, the strategy that I wanted to test out is basically finding options for a stock after it has had an unusual price price spike i.e. more then x standard deviations which has caused the call option price to plummet. This would only apply during trend phases of the market i.e. a clear bull or bear.

Say for example in a bull a pretty stable stock experiences this price spike which causes calls to become underpriced, I would buy (enter with trend) at say a failed double top and as the price would rise and volatility would move back to normal the price of the call would increase at a rate more then that of the stock.

I know this strategy sounds simple, and assuming that the stock does go in the direction that I am hoping for i.e. it continues to trend, is there any reason why my option would not also move back to prices that would be considered normal levels.

I know this strategy sounds simple but with trend trades usually work out pretty well, my only concern would be if the option started moving in the opposite direction.

What you are talking about happens a lot around earnings, like we are in now. Before the earnings comes out, volitility is high. Then after earnings come out, even if they are good and the stock moves up, they take all the volitility out of the options as soon as the news is out so it will make the option lose in value even if the stock is moving up. You can learn about deltas to help with your corroralations to stock price. an 80delta means that if the stock moves up $1.00 the option will theoretically move up .80c. 50 delta, stock up 1.00 option up .50c

spindr0 · Jul 13, 2009

Quote from davewolfs:

What I am getting at is if there is some sort of tool that would allow me to find highly liquid options whos prices move very closely with the stock prices (I could be wrong, but for this case to occur would implied volatility need to remain somewhat constant).

The only stocks where the IV of the options is fairly constant are low beta issues that need a defribrillator to move. Anything that has any kind of volatility is going to have a fluctuating IV based on the inference by traders of the importance of the news.

I doubt that there's anything available on the cheap for the retail guy to test this. Generally, ideas like this take a lot of heavy lifting... sifting through many issues, one by one, to find some possibilities.

spindr0 · Jul 13, 2009

Quote from davewolfs:

Just to add, the strategy that I wanted to test out is basically finding options for a stock after it has had an unusual price price spike i.e. more then x standard deviations which has caused the call option price to plummet. This would only apply during trend phases of the market i.e. a clear bull or bear.

Say for example in a bull a pretty stable stock experiences this price spike which causes calls to become underpriced, I would buy (enter with trend) at say a failed double top and as the price would rise and volatility would move back to normal the price of the call would increase at a rate more then that of the stock.

I know this strategy sounds simple, and assuming that the stock does go in the direction that I am hoping for i.e. it continues to trend, is there any reason why my option would not also move back to prices that would be considered normal levels.

It would seem to me that the nickels and dimes that you might collect from finding options priced below historical IV would pale in comparison to the dollars that could be lost due to getting the direction wrong.

If you're going to put all of this effort into identifying a trend, why not ride that trend for a gain rather than hope that you don't get the trend wrong AND that your lower IV options reinflate back to historical levels? Ignoring pending news releases, when IV rises or drops, how do you know that's over/under inflated versus a new level?

I'm not trying to discourage your search or suggest that your idea won't work. It just seems like there are a lot of moving parts that must function together in order for it to work.