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CM Strategy

Optionalysis: Infy Needs a 10% Move On Results, Otherwise Option Writers Win

Optionalysis

As results come in, its imperative that option strategies will take some priority. Infosys results are tomorrow. Infosys in general has been very volatile in results. So my goodness, we should just buy Infosys calls and puts? Bad idea.

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Infosys Result Days: Lots of Volatility!

Infy results are often big events in that the stock moves a lot. And by that I mean a LOT:

Infy Volatility

The median move on the last 12 quarters is around 6%, and we’ve seen very few quarters where the stock moved little. 6% is a lot, isn’t it?

No: The IV Drop Can Kill You 

The simple answer is: it’s more than priced in, at least in options.

If the market is volatile to either direction, options allow you to create a position to benefit. You can buy a straddle – call and put options at the same strike price – which allow you to benefit if there is a big move in either direction. You only lose if the stock stays at the same place, or at least doesn’t move enough to recover the premiums you pay for the options (call plus put premium, added up). 

But there’s a problem – the premiums could get so high that the “break even” for a strategy is too high. Check out the straddle price for the 1160 straddle yesterday:

Infy Straddle

The premiums, together, add up to Rs. 107. That means the options imply a 10% move (107 out of a stock price of 1160).

Look also at the last column, the “IV”, or the implied volatility – it’s near 52%!

What If IV falls?

On Monday, when the results are done, the IV will fall to a “more normal” 29% to 30%. Because there’s no more of the “event risk” that Infy will have – results will be known.

We have used OptionsOracle (a software used to analyse options) to get the Indian options to work. In that, there’s an option to project out options and how they will be priced if IV falls, if the date changes, if we have a number of positions together.

Here’s how things will pan out on Monday:

• Assumes 250 long straddle positions were bought at the above prices (close price of Friday)

• Current IV of 51% drops to 29%

• How much should the price move, in order to make a  profit?

Answer: A Lot:

Infy analysis

Essentially, long options will lose money between 1060 and 1260 – so Infosys needs to move 10% on Monday just so that an options trade can be profitable

The sea of red in the picture above is the losses that a long-straddle holder will make. Imagine, on Monday if the price moves up to Rs. 1250 (an 8% rise), then the holder of 250 (calls plus puts), who paid Rs. 25,000 for his straddle, will still lose Rs. 2,500 – or 10% of his money!

In Fact, Sellers Are Quite Likely To Make Money

We’ve seen this in TCS before – where TCS moved 4% on options, and yet, it was the straddle or strangle SELLERs than made the money. The Infy trade could just turn out like that – primarily because Infy options are very very expensive, at 51% implied volatility.

Many stocks will show results soon, and when they do, there is a potential strategy to trade them: use options straddles. The criteria to check are:

• Is the implied volatility very high for this stock compared to previous result times?

• Does the stock usually reward option buyers or sellers, at least in the last few quarters?

• It would reward sellers if the IV is very high, and the one day drop in IV takes option prices so far low that even a big move is negated.

• It will reward buyers if the IV drop is not significant or if the stock moves higher than expected by the options.

We have our results calendar, and can see when stocks will announce.

Later in the day, we’ll have an update about what really happened – but when you’re a buyer, the bets are stacked against you. If you’re a seller, you can use this strategy to find excellent option straddles to sell before the event (but only when the odds are favourable). 

And remember, TCS results are on Tuesday. TCS options Implied move is only 5.5% (that is, options expect it to move up or down by about Rs. 140 when the current price is 2630. 5.5% is good and much higher than a TCS average move on results day. And then, you never know the kind of enthusiasm a smart INFY result will lead into: Option straddle values could rise!. Be prepared (and we’ll chat more on Slack!).

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Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion. 

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

Next Gen Financial Analytics

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