DGX - Screaming Upside Skew and a Trade

Discussion in 'Options' started by livevol_ophir, May 3, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    DGX is trading 56.69.

    <img src="http://2.bp.blogspot.com/_hMry1m7UF10/S97lfbBwSKI/AAAAAAAACLI/Rt1H5vdrNas/s1600/dgx_summary2.gif">

    I'll start with the Skew Tab snap (<a href="http://livevol.blogspot.com/2010/05/dgx.html">in the article</a>). You can see extreme upside skew in the front three months - and in particular in the front (red).

    The Options Tab illustrates the details (<a href="http://livevol.blogspot.com/2010/05/dgx.html">in the article</a>).

    You can see the May 65 calls are 0.25 bid with huge OI (long as far as I can tell) and keep getting bid up. The back months are reacting since the vol is so high in the front.

    One thing to keep in mind is that you generally want to buy cheap vol and sell expensive vol - so how about this trade:

    Buy 1 May 60 call for $0.50
    Sell 1 May 65 call @ $0.25

    That's $0.25 for a $5 call spread with growing OI and upside skew. The May 60 calls are hardly "cheap", but at least the spread buys lower vol than it sells.

    Keep in mind, this has a max gain of $4.75 and max loss of $0.25... which means, there is a very low likelihood of success. With the 19:1 maxprofit:maxloss payout, fair value would indicate the odds of hitting max loss are 1:19. Just keep that in mind - this is "probably" a losing trade. If you think the odds are higher than 1:19 to hit max gain, then there is edge.

    Also note, DGX had earnings recently and were down on them.

    This is trade analysis, not a recommendation.

    Details, prices, skews, vols here:
  2. You seem to be disregarding the underlying stock.

    Scant trend.

    What trend that's there is negative.

    Only above $60 for a short time (repelled) and never at $65, making the long leg ......eh........dubious, yet alone with a May expiration.

    I'm too lazy to look and see IF the open interest on puts for those strikes is rising.

    55 1/2 is a critical point. Ditto for $59.86. I'm also too lazy to see what an August or September 55 1/2 puts are, but that's what I'd look at irrespective of skew.

    I give no credence to earnings other than as an alibi to move paper. Specialist moves the paper, CBOE tags along.
    • dgx.jpg
      File size:
      53.2 KB
  3. livevol_ophir

    livevol_ophir ET Sponsor

    Agreed. Stock looks bad, didn't like earnings.