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Volatility Correlation and Company Fundamentals

One of the more interesting parts of trading options is how perceptions of volatility and stock price movement relate. Generally, when you see a stock move down, vol goes up; the converse happens on a runup. There are exceptions to this rule-- for example if a name gaps up big and runs on earnings, the forced covering of option shorts will hold vol up as they have to buy premium.

This volatility voodoo is often labeled as human perception. However, there may be a fundamental factor that comes into play. Consider this exceprt from a post by CSS Analytics:

[...] changes in the stock price, whether rational or not, can have actual financial implications for a company’s cost of capital. But it does not stop there. Like any complex system, this process involves multiple feedback loops, where the drop in the stock price can cause increases in the cost of capital, which in turn can cause further changes in the stock price.

The whole piece is worth a read, and it goes into an explanation of snapback rallies in awful names, and how vol begets vol.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/