As traders know all to well, volatility moves inverse to a stock … except when it doesn’t. One time it doesn’t is when volatility is pumped ahead of a news event, and the news is bad. The stock will decline, and the volatility very likely will, too, as the news premium dissipates. That situation doesn’t really give us anything tradable.
Another case does, though. When a stock rallies to new highs, volatility generally trends down, often hitting new lows. Apple (AAPL) is one stock where we see that happening. But when that move starts to take on “melt-up” qualities, volatility starts to actually reverse course and tick up again. And currently we’re seeing this interesting volatility set-up in Netflix (NFLX).
Netflix’s Volatility Contradiction
We saw a garden variety bid up ahead of Netflix’s recent earnings announcement, with 30-day normalized options volatility lifting from the low 30s in mid-March to about 58 ahead of last week’s earnings report. That was high, but not stratospheric as the stock itself started moving at a mid-40s volatility clip.
And then the earnings came. The stock exploded, shooting from $87 to $100 on Thursday. And, as expected, implied volatility regressed, closing back under 40.
But then it got interesting. Monday saw NFLX on the move north again, up near $110. This time, however, options joined in the fun. May volatility spiked 10 points to about 49.
For one thing, this is a reminder that volatility works in both directions. We tend to think of volatility as a monster that only rears its head on the downside. Not quite. Shorts get trapped and scramble for paper. too.
For another thing, it’s often a sign that the move is getting into a blow-off phase. This is purely anecdotal, but the “stock soaring/volatility soaring” combo was very common in the tech bubble, not to mention other occasional momentum-laden names over the years — Taser (TASR) and DryShips (DRYS) come to mind. I’m not saying NFLX is going that route, but I would call this a warning flag.
Of course, the story will not end here. This volatility contradiction has to be resolved.
If NFLX backs and fills a bit toward $100, volatility will likely decline, too, which will look odd as you can buy puts here and see the stock decline and perhaps have that directional win offset somewhat by the volatility hit.
The flip side is if you buy puts and the stock keeps rallying, you won’t lose as badly as you typically would as volatility will likely hold strong.
Personally, I went the spread route with Netflix. I bought put spreads and bought a small amount of stock as an (under) hedge. It’s more a statement that I don’t anticipate NFLX stock to settle near here, nor do I expect options volatility to stay this high if NFLX declines.
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