The option MM prices options according to anticipated change in implied volatility when it comes to these out-of-the money options. The implied volatility reflected in the premium of the option is basically the chance related by the option trader to the option that it will be at its strike price before its expiration date which is also reflected in the option's delta as the stock price nears the strike price of the option. However, split plays are one exception. The premium of the option is a reaction of the public to the split announcement as traders make a play on this news event. This option price can "float" more independently from the price of the underlying stock as a consequence of this split play activity.
If this price action on the option is as Judy is saying the result of this stock coming off of the hype associated with a split play, then it is normal consequence of the out-of-the-money option being used as a play on the sp;it news event and later the on the runup that can happen after the actual split. This begins as an implied volatility skew with the out-of-the money options by one strike getting purchased by the public as a cheap play on the stock on the heels of the split announcement which will temporarily drive up the premium of that option compared to other CALL options at different strike prices. This increase in premium is followed by a comparative decrease in premium in a few days after the split announcement as the option players who were quick to jump in are taking profits. This is what makes trading options surrounding news event much more tricky and IMO to be avoided for the initial few days after the news comes out, because that beeper crowd will always get there before you. After the initial swell and contraction in options premium in relation to the price of the underlying security, then trading the option will be less risky in potential premium loss.
Splits have their own cycles they go through as far as the underlying stock is concerned. First there is an initial interest to make some quick money off the split news event. Profit taking comes two to three days afterward. This is when the trader who wants to enter will gauge the pullback. If the stock does not pull back much but instead continues forward, then there is strength that can carry it forward for a period of time. Otherwise the stock will base until the stock split date gets closer. Then the runup of the stock usually continues one to two weeks before the split date.
With some split plays, the runup of the stock will start earlier than this time period, and with others it may start only a couple days before. The stock indicating weakness before and after the split announcement are more likely not to have a good strong runup before the actual split date. Also stocks that have had good earnings momentum and an associated runup earlier in the year are good candidates for a split play because the public's attention and positive sentiment is already on the stock. It helps if the split announcement is part of a series of positive news statments made by the company such as an earnings surprise and a stock buyback program that was announced near the stock split announcement. Monthly volume turnover can help to determine how forcefully the stock will respond to the split announcement. The price action of the stock after the split announcement will also depend on how long the time period is between the split announcement and the date of the actual stock split.
After the split occurs there will be another strong bout of profit taking. Some players will sell only half of their holdings and keep the other "free" half, so they reason, in order to profit on any continued near timer price appreciation in the stock. There may be a basing period here, or the stock may continue up more before its basing period. If it is a popular stock with good future prospects where the public is used to seeing the stock priced at its former value, the stock can continue up toward its former price as time goes by. DELL is a good example of this type of stock. Continued positive earnings growth and earnings momentum will help here.
I have not been following this stock amd do know know the ex-split date. However, the most impact the split announcement will have on the options is usually in the first few days following the split announcement, and then I think perhaps right before the ex-split date. I see the split was announced in Feb and occured in March followed by a basing period. So I do not think the options activity we are seeing is the result of any split hype. Earnings was announced in May with a not so unusual drop in the price of the stock following the earnings announcement on the heels of a nice runup of the stock.
I do see the stock broke out from a resistance level and shot upwards. Funny things can happen to option premiums around resistance levels. I do believe the option MM is aware to some degree of the technicals of the stock that they trade options on or at least is noting the price action around price areas like support and resistance and what this price action would imply. After the breakout, the premium will move up with the public making a play on the breakout using options on the stock.
Just for your information. Hope this helps.
Comments welcome!
Bob Graham |
