Advanced Options Strategies: Measuring Sentiment

An article by New York Institute of Finance Options instructor McCabe Hurley.

Options can change less than or in excess of what delta implies for any number of reasons, including:

To accommodate supply-demand imbalances
Typically normalizes after a short time
Calls & puts of the same strike will return to trading at same implied volatility
To adjust for a change in market opinion of volatility
Implied volatility moves up or down as markets forward view changes
To adjust for a change in market views of financing
Financing changes due to changes in:
Interest Rate used to borrow/lend money
Dividend paid on stock, stock going ex-div before expiration
When option prices move in excess of expected delta move you can determine which variable changed by:

Checking the straddle
If the straddle has changed (implied volatility changed) then view on forward volatility has changed
If straddle is unchanged could be financing
Checking the forward price
If the forward price has changed we need to determine which variable changed
Could be the cost to carry or the dividend
Cost to carry: rates higher or stock is harder to borrow
Dividend: could be raised (instituted) or cut
Example 1:

To illustrate this process, let’s use these variables as our starting point:

Stock trading @ $65
Calls 3.44
Puts 3.06
Check straddle $6.50
Check synthetic fwd 65 + 3.44 – 3.06 = $65.38

Example 2:

Stock trading @ $65
Calls 3.32 (- .12)
Puts 3.19 (+ .13)
Straddle $6.50 (unchanged)
Implied volatility unchanged
Syn. fwd 65 + 3.32 – 3.19 = $65.13
Either cost to carry or dividend changed
Cost to carry lower or dividend higher
Cost to Carry check:
Call stock financing desk, ask if stock has become hard to borrow
Check if earlier exp synthetic forward has change.
Also check the 30 day option prices and see if synthetic forward reflects lower cost to carry

30 day options with stock trading @ $65
Calls 2.40 (31%)
Puts 2.21 (31%)
Synthetic Forward $65.19
Actual forward = 65 * (1.035)^30/365 = $65.19
30 day forward is unchange

If stock became hard to borrow all shorter expirations forward would have changed to reflect new stock borrow rate
This implies dividend has changed (increased)
Specifically, market thinks stock will pay a .25 dividend
And will go ex-dividend after 30 day exp & before 60 day exp
Now, remember this is merely the markets expectation and may or may not come to fruition. It is illustrated here to show you one of the many ways options prices (and their Greeks) can be used to glean information about forward expectations.

We would likely expand on this and check our skews to ensure they are responding in some logical fashion - A subject for another day.

Dividends and carry rate do not change all the time, the variable which will tend to change the price of options intra-day are:

Stock Price
As stock trades up or down, options will change by roughly the delta amount
Stock higher = Calls higher, puts lower
Implied Volatility
Equity Option Market Makers tend to
Raise implied volatility as stock trades lower
Lower implied volatility as stock trades higher
Commodities (Energy) Option Market Makers tend to
Lower implied volatility as energy futures trade lower
Raise implied volatility as energy futures trade higher
When there is a large trade which dislocates option prices
The put-call parity will be out of line for a short time
MM will adjust prices up or down so the put-call parity is back and so they can cover their risk

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