Unusual Volatility Situation in BIDU

06/29/2010 12:01 am EST

Focus: OPTIONS

Adam Warner

Author, Options Volatility Trading

It's certainly not unusual for the market to modestly overprice options. In fact, that's standard procedure. As a basic rule, net option selling works more often than not. The issue, of course, is that when "not" happens, the losses are open ended. And even if not disastrous (a la 2008), they tend to dwarf gainers in magnitude.

BIDU is no real exception here. Thirty-day implied volatility still sits in the mid 50s despite the fact that ten-day HV has sunk under 40.


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What makes the current setup somewhat interesting is that this relationship exists with BIDU options relatively pricey in relation to its own history. A 55 volatility is considerably off the highs of May, but it's very much high end. So if you net buy here, you're first betting that HV will lift 50% or so (certainly possible), and you're betting that options will believe it's more than just a blip and lift too.

The nickel version is really that if realized volatility was sitting at lows, like say, SPY at 7 in April, it's very reasonable and expected to see options trade at a premium to that. But with HV in middle ground, it's less expected to see options maintain a similar relationship. Do they "know" something, or is everyone just too nervous? You make the call.

By Adam Warner of DailyOptionsReport.com

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