Friday, May 23, 2014

* KNDI, TWTR, NFLX - Has the Option Market Fallen into a Correlation Malaise; Under-priced Risk in MOMO Stocks?

KNDI is trading $11.53, up 4.6% with IV30™ down (again) 4.0%. The Symbol Summary is included below.

Provided by Livevol

This is a follow up to a recent post on 5-15-2014 (eight days ago). You can read that post here:
Kandi Technologies (KNDI) - Stock Rockets then Implodes... But is it in Equilibrium Now?

With VIX dipping to multi-year lows, several MOMO technology names are also seeing implied volatility (equity price risk in the near-term as reflected by the option market) dipping to lows. KNDI is one of those names, and does beg the question: Is the option market under-pricing risk?

Perhaps the option market has fallen into a correlation malaise, applying the same risk standards across a large body of stocks (like the S&P 500) and has not (necessarily) properly identified risk in individual names.

Another two recent examples of this are TWTR and NFLX.  You can read those posts here:
Twitter (TWTR) - What Now? Option Market Reflects Low Risk; Last Two-times that Happened, Stock Moved Huge.

*Netflix (NFLX) - 5 Years of History, Evolution & Everything You Want to Know. One Day of Risk Analysis: Is the Option Market Wrong, Again?.

Let's get into it with KNDI, starting with the three year stock price chart.

Provided by Charles Schwab optionsXpress

We can see that KNDI has been resurrected from a relatively unknown baby market cap penny stock (~$2) to at one point, not too long ago, as high as $22.40, and now 50% lower in two months.

The question has become, is this the fair value "equilibrium" price for KNDI or is there some other (very different) price the stock will tend to (up or down)?  One way to answer this question is simply to look at the option market, which explicitly reflects the risk in the underlying price in the near-term (and really, any horizon).

Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

That little yellow vertical hash represents where the volatility was when I posted the 5-15-2014 note.  I asked then if the volatility was appropriately priced and if KNDI had found equilibrium.  As of that post KNDI stock was $11.95 and the IV30™ (30-day forward looking stock price risk) was 94.75%.

The last eight days point to a pretty simple and clear answer: "Yes, this is equilibrium." The stock hasn't really moved, and forward looking risk via the option market is even lower.  Hmm...

We can also see in the chart above that the implied has seen a relatively straight line down move since earnings.  A big drop after an earnings release is normal (and expected), but the continued dip feels more like a general market risk deflation than anything specific to KNDI.  That means... perhaps the option market has fallen into a malaise, applying the same risk standards across a large body of stocks and not (necessarily) properly identified risk in individual names.

Finally, the Options Tab is included below.

Provided by Livevol

The great thing about options is that the prices reflect a clear and absolute price range "guess" for a time period.

using the Jun $11 strike straddle, the option market prices a range of [$8.80, $13.20] by the end of trading on Jun 20th.

  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

This is trade analysis, not a recommendation.

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