MMR Options Implied Volatility Is Too Rich

by Tyler Craig | July 23, 2012 8:59 am

The behavior of implied volatility surrounding an earnings announcement is a fairly reliable phenomenon. The elevated demand for option contracts lifts implied volatility into the event, while the excess supply of options drops implied volatility after the event. While the pre-earnings ramp tends to be gradual, the post-earnings drop tends to be a rapid event.

This predictable drop in volatility following earnings is why most savvy traders like to hold short vega positions heading into the announcement.

Every once in a while you’ll see implied volatility buck the conventional trend and remain elevated even after an earnings announcement. The implied volatility of McMoRan Exploration (NYSE:MMR[1]) options have just followed just such a path. Even though the uncertainty associated with MMR’s earnings on July 17 is now in the rear-view mirror, implied volatility still sits at the upper end of its range and at a hefty premium to recent historical volatility.

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As displayed in the volatility chart provided courtesy of, implied volatility (gold line) is still hovering close to 100%, while 30-day historical volatility (blue line) is down at 75%. It appears options have been persistently overpriced on MMR for the entire year, with the best opportunities coming for option sellers anytime implied volatility poked its head above the century mark.

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Given the cheap price tag and overall uptrend present in MMR’s stock price, selling put options may not be a bad way to go here. Traders could sell to open the August 11 strike puts for 55 cents or better. The max reward is limited to the original $55 credit received and will be captured if MMR remains above $11 by August expiration — a feat quite likely given MMR’s current bullish trend.

If the stock falls beneath $11, traders are obligated to buy 100 shares at a cost basis of $10.45 (the $11 strike price minus the original 55-cent credit received).

At the time of this writing Tyler Craig had no positions on MMR.

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