How Should I Approach High Implied Volatility Stock Options?
Posted by Pete Stolcers on July 22
Option Trading Question
Every month we can always find options with very high implied volatility, especially from pharmacuetical companies that are waiting for FDA approval. Is there any proven way to profit from this situation regardless of the decision of FDA? (please, don't recommend a straddle)
Option Trading Answer
Anytime you see a spike in implied volatility it tells you that uncertainty has entered the picture. The professionals that make markets in that underlying attach a probability to the various outcomes and they calculate the impact on the profitability of the company. Then they price the options using complex proprietary algorithms. They have a staff of analysts running through the numbers and making phone calls within their network to try and find a shred of information that will give them an edge. I’m sure in some cases they have an employee in the courtroom waiting for the verdict to be read. In the end, I can’t compete in this arena. These large institutions have millions to throw at the event, I do not.
I run from these situations and I view them as a crapshoot. If you see a steady climb in IV and the stock has not moved, it means there is news pending.
Look for situations where the outcome is predictable - like a stock with a nice tight trading pattern and consistent earnings. Form an opinion, take a stand and know when to admit you are right or wrong (target, stop).