Monday, March 17, 2014

Insmed (INSM) - Event is Coming; Option Market is Thoroughly Confounded: Biotech What?

INSM is trading $19.26, up small with IV30™ down 0.5%. The Symbol Summary is included below.

Provided by Livevol

Insmed Incorporated is a biopharmaceutical company focused on patients suffering with lung diseases through the development and commercialization of targeted inhalation therapies.

This is a crazy volatility note which is also a follow up to a prior post:
Insmed (INSM) - Biotech Has Huge Event Coming.. But When? If you Know That, Then You Have a Play.

That prior post offered this conclusion:
It seems that there is an event due out, but the final delivery date of that news is a bit of a toss up... Is it in Mar or is it in Apr?

As of this morning's volatility readings, it appears that the event is due out after this week (mar expiry). But the skew is so odd and so divergent, that this is now one of the most confounding volatility set ups I have ever seen.

Let's jump into it. First, the Charts Tab (two-years) is below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

Provided by Livevol

On the stock side we can see the enormous price appreciation from ~$2.50 to now ~19.50 in less than two-years.  But this is a volatility note, and it is wild.

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

Provided by Livevol

First, we can see that the implied has been exploding of late.  It's obvious that an event is due out very soon and the options reflect hugely elevated risk.  This isn't really the weird part -- biotechs live and die by these events.

The first question is, is the event coming in the next week (Mar expiry) or is it due out after Mar?  Let's turn to the Options Tab, before we look at the ridonculous skew.

Provided by Livevol

Across the top in green font we can see the volatilities by expiration.  Note that Mar is down 54.7 vol points today to 224.07% while Apr is almost unchanged to 233.13%.

So as of right now, the option market reflects basically a coin flip if the event is due out in Mar expiry or Apr expiry (vols are about equal). But, on Friday, (before the huge drop in mar vol) the option market reflected a greater chance of the event occurring in Mar.

Friday's Close:

Provided by Livevol

Look at that... Mar volatility was up 42 vol points on Friday and has totally reversed today.  On the close:

Mar vol: 279%
Apr vol: 234%

Mar vol: 224%
Apr vol: 233%

Again, Mar is the one changing.  But believe it or not, that's not the incredible phenomenon about the vol.  It gets way weirder.

First, let's turn to the Skew Tab as of 2-27-2014:

Provided by Livevol

Back on late Feb, we saw two things:
1. Apr vol was greater than Mar vol across the board, hinting that the event was likely in Apr.
2. Both months showed a similar skew shape.

Now, look at today's skew:

Provided by Livevol

Pardon my acronym, but WTF?

The at-the-money volatilities ($19.5 strike) are nearly identical.  But that's where the similarities stop.  Mar skew shows a wild upside tilt, reflecting substantially more upside potential (risk) than downside.  Just look at the enormous gap that has opened up on the right hand side of that skew chart between the red curve (Mar) and the yellow curve (Apr).

Apr skew reflects less upside and downside risk than Mar, yet elevated near-the-money volatility.

Some explicit examples:
Mar 25 calls vol: ~275%
Apr 25 calls vol: ~2233%
Mar 30 calls vol: ~300%
Apr 30 calls vol: ~213%

Mar 35 calls vol: ~335%
Apr 35 calls vol: ~202%%


Either the event is Mar, or the event is in Apr, but why would the timing affect the shape of risk (skew)?  Why does Mar reflect such upside potential and Apr not?  Is the option market wrong?  Actually, not necessarily.

It's possible that if the news of this event breaks "early," then apparently that has a greater potential of being good news.  if the event comes out later, that "delay" may mean risk of a worse outcome.  Whether that's true or not I don't know, but the option market is reflecting exactly that reality.

To read more about skew, what is and why it exists you can click the title below:
Understanding Option Skew -- What it is and Why it Exists.

The risk as reflected by the option market has whipsawed over two trading days, where Friday saw a conclusive shift in risk that Mar was in fact the expiry of the event, to Monday (today) where the option market has totally reversed that view. And...

As of today, it appears "early" news has a greater potential of being positive for the stock and "later" news has a greater potential for negative news.

How to trade this
First, do some research.  What is the event and what is the timing?  If you have a feeling you get it better than the option market does, any time there is a huge divergence in skew shape, that means a spread is on the table.  It does not however mean, that a spread is a winning trade.

In any case.  This has been one of the most interesting volatility evolutions I have ever seen in a biotech, or any other firm.

This is trade analysis, not a recommendation.

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