Thursday, November 11, 2010

Discover Financial (DFS) - Call Skew Goes Bid on Takeover Rumors

DFS is trading $18.84, up 0.6% with IV30™ popping up 11.1%. The LIVEVOL™ Pro Summary is below.


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"Shares of DFS are surging this morning on renewed takeover chatter ."
Source: Click Here.

The company has traded over 18,000 options on total daily average option volume of just 2,327. With just 500 puts trading, calls have traded on a 32:1 ratio to puts. The Nov 19 calls have traded over 9,000x. The Stats Tab and Day's biggest trades snapshots are included (below).

The Options Tab (below) illustrates that the calls are mostly opening (compare OI to trade size). The Nov 19 and and Dec 19 calls look like buyers today from what I can see. The vol pop and skew shift (see below) provide confirming evidence.

The Skew Tab snap (below) illustrates the vols by strike by month.

I really like this set of curves. The Nov upside is bid and then some. Dec is bumpy but not as skewed up. The vol difference between the Nov and Dec 19 and 20 calls is fairly substantial.

Finally, the Charts Tab (6 months) is below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

We can see the stock has steadily climbed over the last 6 months. As of today the IV30™ has passed the HV180™, and it's already well above the HV20™. In English, the short-term implied vol is now above the long-term realized vol and the short-term realized vol.

Possible Trades to Analyze
1. Spread the Call Skew:
Buy the Nov 19/Dec 19 call spread for $0.45
Buy Nov 20/Dec 20 call spread for $0.35

You can close these trades on Nov expo instead of holding those Dec calls if the trade works out.

2. Spread the Dec call skew:
Buy the Dec 19/20 call spread for $0.40.

3. More bullish (blah): Sell the Nov 20 calls @ $0.15 (there is liquidity there) and buy the Dec 19 calls for $0.80.

This is trade analysis, not a recommendation.

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  1. Can you explain how you arrive at the assumption that the call trading is net buying? When I look at the DEC 19 Calls trading 4000+ volume with only 324 OI doesn't that mean that most of the transactions were closing transactions?

  2. When volume is >> OI, it has nothing do with the side (buy or sell), it means the trades are opening. I could tell they were purchases b/c:
    1. Prices
    2. Vol increase

    Specifically, in this case, there were 324 net open positions (there were 324 longs or 324 shorts). When 4000 traded, this is clearly well above that OI, so it's opening to one side or the other.

  3. So should the OI be substantially higher the following day?

  4. yes, that would sort of be the proof that is was opening.