OTM call spreads vs OTM put spreads on very high IV

Top-line data is expected from two of Ophthotech Corp (NASDAQ: OPHT)'s pivotal Phase III trials in the next month. Leading into the catalyst, which could take the stock either way, Stifel analyst Stephen Willey maintains a Buy rating and $75 price target on the stock, representing about 135 upside potential.

In addition to the firm's bullish price target, Willey provided an assumed negative scenario of $7 per share in the event of negative data and $100 to $120 per share in the event of a positive report.

The analyst acknowledged three necessary warnings against Stifel's scenario:

Distinctions in mechanisms between Ophthotech’s Fostiva and Regeneron Phamaceuticals Inc (NASDAQ: REGN)'s failed rinucumab.

Comparison between “largely uninterruptable” Phase I results.

Phase IIb data on Fostiva lacking anatomical evidence.

Taking the caveats into account, Willey said the current Ophthotech valuation favorably resets the risk/reward profile.
 
Ratings and targets: Some a bit old though...

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Maverick74 said:
I definitely think the upside fly is the best way to play it. Also, count on a strong fade after a positive pop.
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But, might as well just buy the 60-70 CS for about $2 and have full upside for anything above 62. Also about 400%. That condor gives a lot higher return though between 70-80.... just nothing beyond. That's the problem here, where does it stop?!
 
@Maverick74 That makes sense though, that's the 'call of last resort'. They won't introduce any new strikes until we hit 90-100, so with any upside risk this is the call to own... lowest cost.
Even if you're short say the 70 call and you have a massive blowout in risk, this call can fend of your bank's risk dept. Although it doesn't really work at +100% and vol crush. Risk still blows out.

For some reason I can't see OI at this time. How's the 65, 70 doing? My guess is that's the real interest. Shorts in that strike might have bought x2 or x1.5 the 95 as hedge...
 
Did they just make new strikes in Dec?? 50 cents strikes between 27 and 40... someone must be worried about nothing happening next week and having big positions without real hedging possibilities in the last days of trading...
 
JackRab said:
Okay, after a bit of fiddling around I've come to the conclusion that, because options models use an approximation of a normal distribution adjusted for tails (don't know technical terms here)... this seems to go haywire at extremes (which makes sense since you can't rely on anything normal in the extreme).

Butterflies which follow a normal distribution across strikes in normal conditions... the (near) ATM butterfly has the highest value.... also gamma is highest near ATM. In my example it seams the butterfly peaks somewhere at the bottom... or left however you look at it.
This doesn't make sense at all.... :banghead::confused:... then again, maybe it does.... :(

Where's my quant when I need him!!!!!
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My intuitive understanding as to why you see the two effects:

The put spread being more expensive than the callspread has to do with the putspread roughly representing the probability of being over that range (like a binary). Delta is not the probability of being in the money. It's actually N(d2) in the BS formula. Black-Scholes assumes there is downdrift to stocks (like in the 2x ETFs) and that over a long enough timeline, all stocks go to zero (like Fight Club). The higher the volatility, the faster it will go to zero. So with a high implied vol, the option is saying that it's much more likely this stock will go to zero within the expiry.

The reason the delta is higher for the call than the put is because as vol approaches infinity the option starts to look more like stock: the difference between strike and spot becomes meaningless and the likelihood of having to hedge a stock going to infinity causes the delta of the call option to be high (if you were to look at it in a binomial tree and risk neutral valuation).
 
newwurldmn said:
My intuitive understanding as to why you see the two effects:

The put spread being more expensive than the callspread has to do with the putspread roughly representing the probability of being over that range (like a binary). Delta is not the probability of being in the money. It's actually N(d2) in the BS formula. Black-Scholes assumes there is downdrift to stocks (like in the 2x ETFs) and that over a long enough timeline, all stocks go to zero (like Fight Club). The higher the volatility, the faster it will go to zero. So with a high implied vol, the option is saying that it's much more likely this stock will go to zero within the expiry.

The reason the delta is higher for the call than the put is because as vol approaches infinity the option starts to look more like stock: the difference between strike and spot becomes meaningless and the likelihood of having to hedge a stock going to infinity causes the delta of the call option to be high (if you were to look at it in a binomial tree and risk neutral valuation).
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I don't think this is true. BS assumes an "upward drift" using the risk free rate in the market. It has to do this because the long stock holder is assumed to have to earn at least the risk free rate of return to want to hold the stock to begin with. The BS formula therefore follows random stochastic process but one with upward drift that is equal to the risk free rate of return. If there was a downward drift in all stocks over time no one would hold stocks unless the equity premium exceeded this downward drift.
 
Maverick74 said:
I don't think this is true. BS assumes an "upward drift" using the risk free rate in the market. It has to do this because the long stock holder is assumed to have to earn at least the risk free rate of return to want to hold the stock to begin with. The BS formula therefore follows random stochastic process but one with upward drift that is equal to the risk free rate of return. If there was a downward drift in all stocks over time no one would hold stocks unless the equity premium exceeded this downward drift.
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Black scholes assumes arbitrage free pricing which has the cost of financing built into the forward. Today rates are practically zero especially in the context of a high implied vol stock in Jack's example.
If you price a 100 year put under the black scholes model, the put will be worth almost max value (strike price). It's a nuance in the model - Warren Buffet highlighted it as an (flawed in my opinon because his tenors weren't long enough) argument for his infamous put short.

If you have constant vol (under the black scholes framework) all stocks behave like a 2x fund. 100 becomes 101 becomes 99.9, etc. And over a 100 years it will eventually go to zero.

I agree that this part of the model doesn't fit with the reality of the world, but that's why the model shows the greeks it does.
 
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