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Price Over Strike and Best Buy Options

You're going to get an options pro-tip today: how to measure expected movement going into options expiration, and we'll use BBY earnings as an example.

The options market is essentially a function of extrinsic value and how it relates to the Giant Bell Curve. Calculations of implied volatility and other readings come into play, but a quick and dirty reading for vol is what's known as price/strike. To calculate this, simply take the ATM straddle and divide the current price over the straddle strike.

So what is this actually doing? Well if you sell a straddle, your breakevens are going to be the price you sold it for plus or minus the strike price. So when you divide the price over the strike, you are getting the percentage move needed to stay breakeven.

Best Buy reported earnings this morning. The guided down for 2011 and the mkt is not happy about that, and the stock is currently down 11.3% off its close. Was the options market pricing it in? There are more complicated measurements that you can do related to historical vol drops (and I explain these in detail in EarningsTrades), but we can just use the price/strike calculation since we are so close to expiration.

Remember, when you look at options premium, there are two components: time and vol. As opex is only 4 days away, the majority of the premium is related to vol, not time.

The market was pricing in a 6.87% move by this Friday. Since we are seeing a large gap outside of this expectation, it may force those who sold puts or vol to cover, which can exacerbate the situation. The gap fill of 34.75 could be a reasonable target, as that is the gap fill from the previous earnings event. Other support levels are 36 and 31.

Will this have a similar vol squeeze like LULU did? I doubt it, as there are other factors coming into play, such as where the open is relative to 52 week highs. Since the stock is not breaking down key long term support, the stop loss run will not be as great compared to LULU; furthermore, the all time high plus high short interest helped LULU. So after the smoke clears, I'm not expecting 31 to break on the first test.

by Steven Place

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