Wednesday, March 10, 2010

GameStop (GME) - Earnings Play with Options and Vol Divergence

GME is trading 18.18. The LIVEVOL™ Pro Summary is below.

Note that the company has earnings 3-18-2010 Before Market Open. That's the Thursday of expo. See the calendar below which highlights the earnings date and expiration.

The Skew Tab snapshot is included (click to enlarge). Notice the extreme vol in the front month (red) relative to the other months (and specifically the second month - yellow).

Skew Legend:
Red - Front month
Yellow - Second month
Green - Third month
Blue - Fourth month

Earnings is a vol event and as the number of "normal" vol days lessen and the "vol event" becomes a greater proportion of the volatility you can see this type of divergence. The Options Tab snapshot is included - click to enlarge.

I've highlighted the Mar and Apr ATM straddles. You can see the fair value for the Mar ATM straddle is ~$1.55. The Apr is ~$2.17 or $0.62 higher. Note that Mar IV is 98 vs Apr IV of 45 (top of the snapshot).

Finally, the Charts Tab (1 year) is below (click to enlarge). Note in the upper portion (the stock price) you can see the earnings dates denoted by the "E" icons. While the stock is certainly volatile right after earnings - it does have a tendency to move substantially a few days after earnings as well - in this case we're looking for movements 3 days after earnings or more.

Hypothetically someone could sell the high vol straddle (March), buy the low vol straddle (Apr) and pay ~ $0.62. After two days the high vol straddle expires and that trade leaves you with an Apr straddle. This trade can certainly lose - especially if the move on earnings day is huge. But if the move isn't that big, or alternatively if the stock is volatile several days after earnings (like in the past), someone could own a cheap straddle with a lot of vol to come.

This is trade analysis, not a recommendation.

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