Help with GOOG IV and pricing

I've been reading this forum for a few months and have learned a lot. But my first post is a cry for help.

I bought 4 GOOG Sep 450 puts this morning. I was looking for a retracement to the 50SMA and I got it. Stock was down $8...but I broke even.

I got in at $4 at ~10am with GOOG at $489.75. The pricing and spread didn't seem unusual for most of the day. Then at about 2:30 the bid dropped from 4.20 to 3.80 instantly, then down to 3.50 in another 10 minutes or so, even as the stock was dropping from 486 to 485. The ask was still at 4.40 for a couple of minutes after that. (I originally thought there might be news or something to explain the .60 spread.) Earlier in the day the spread was 4.30 - 4.40 when GOOG was near 486.50.

After that, the pricing and the spread were pretty erratic. Here are some quotes from the last ~40 minutes of regular trade:

GOOG GOOG 450 Puts
484______3.60 - 3.90
482.50___3.90 - 4.10
482______4.00 - 4.20
483______4.00 - 4.10
483.10___3.80 - 4.10
482.60___3.90 - 4.20
481.80___4.00 - 4.20
482______4.00 - 4.30
481.92___3.90 - 4.20
482______4.10 - 4.20
481.70___4.00 - 4.30

Was the initial drop due to some kind of IV change? What would cause the erratic pricing after that? Do those who trade GOOG see this often?

Definitely a "low frequency trading" day regardless - there were times when 20+ seconds would go by with no trades in GOOG today. :eek:

Before this situation today, I was pretty comfortable with using options as a surrogate for stock (to gain leverage and minimize risk). I haven't seen anything like this while trading SPY or DIA options. Any advice on what to read to learn more about IV-related intraday phenomena (if that's what this was), and what to watch while trading? Some background: I'm using ToS via Ameritrade. I usually day- and swingtrade SPY (with a lot more success than GOOG today!). I watch 5 and 15-minute charts with SMAs, charts of $TICK and VIX with SMAs, $ADVN/$DECN, /ES, and EUR/USD, as the main indicators.

Thanks in advance for any insights!
Will

 

Will,

I am certainly no expert on GOOG and I wasn't watching it today or anything, but I can imagine the IV may have dropped somewhat when the overall market gained in value (seems odd that it would when GOOG was dropping I admit, but the overall market fear (VIX) can have a large impact).

Also, in general, the 450s are still a ways away from the stock price. So, actual stock price moves don't mean as much to the further OTM compared to closer to the money options. I think what you saw was more trading in and out of the options and some VIX drop compared to any put value increase from GOOG price drop.

That being said, if GOOG fell $8 tomorrow, you would likely do better, and then if it fell $8 more the next day, you would be better again, etc. This is because GOOG falling below $450 would seem more realistic to traders then it does now. I would also guess that if the market IV spiked up even if GOOG stayed about the same, you would also see the opposite phenomenon of what you saw today - the stock might not move much, but the puts could gain quite a bit.

So in general, you would see much more upward movement from the puts as the stock falls closer to the strike (with still enough time of course) and/or market/GOOG IV increases.

Of course, this is just my view from a fairly quick read of your post and a quick check on the daily prices, etc.

JJacksET4

 

Will,

I just took a quick look at the VIX chart.

http://finance.yahoo.com/q?s=^VIX

->If Link doesn't work, just get quote for VIX on yahoo.-<

It looks like the market IV was around 25 when you bought the puts and fell to 23.5 later. This certainly seems to be a reason why the puts didn't do as good as you might have liked (along with the fact they are still a fair amount OTM).

It certainly wasn't good news for the puts that while your stock (GOOG) fell, the market recovered losses and then drifted, which pushed the VIX down from where you bought the puts.

JJacksET4

 

Thanks for the reply, Jacks, and good point about the VIX. That's why I always have the chart up during the day. It did come in significantly between 12:50 and 1:10, but was pretty flat an hour or so later at the moment the bid collapsed on the options. The spread was surprisingly strong on the options during the VIX collapse, but it was because GOOG stock was essentially flat while the market spiked (SPY went straight up from 109.60 to 110.26 in 30 min).

I've daytraded GOOG puts and calls a few times in the past and have never seen this kind of price action before. (I actually bought some Sep 520 calls for $3.10 at 9:50am and sold them for $3.30 at 10:08, so things were normal on the call side this morning as well.)

The delta on the 450s is about 20, but since they move in 10-cent increments they can have a pretty big range when the stock moves a few points.

I guess my main point is that prior to 2:30, the options traded in lockstep with GOOG, in line with their delta, but after the sudden premium decline, they were very erratic.

 

Here's what I see in time&sales.

@ 2:20 the bid was 4.20 (IV around 30%).

@ 2:22 there were 2 trades totalling 100 contracts @ 4.17, and then several more for another 50 cons in total @ 4.18, with the market being 4.10 bid at 4.20.

@ 2:35 there were several trades totalling 184 cons @ 4.10, with the market being 4.10 at 4.30 prior to the trades. These trades pushed the bid down to 3.70-3.80, with IV down to around 29%.

Until around 2:50 there were more trades coming in and @ 2:55 the bid dropped down to 3.60, with IV down to 28.5%.

@ 3:00 the bid was down to 3.50, with IV down to 28%.

Between 3:00 and 3:20, there were some trades at the ask, however the IV stayed at around 28%.

By the close the IV dropped down to 27.7-28% area.

To sum up, the drop in the bid you saw around 2:30 was the result of the trades hitting the bid. And the reason you only broke even on the trade is that the IV dropped from around 30.5-31% at the time of your trade to 27.7-28% at the close.

 

Thanks, MTE, for pulling out the trades from T&S. I guess the surprise to me is that the option price would be so decoupled from the price of the underlying and so influenced by trades. Maybe it's from trading SPY so much (obviously more liquid), but I assumed option prices -- at least on liquid securities -- would have less of a supply/demand relationship. Is there a factor in the B-S pricing model to account for this?

I'm also unsure why IV would decline so much while the stock was dropping 2%.

Just to be clear, I broke even because I bought/sold at $4. I could have sold at $4.30 or $3.50, but held on because I thought the retracement to the 50MA would correspond to about $4.50 - $4.60. Clearly I need to understand better the impact of some of these other factors and not assume as direct a correlation between the option and the underlying as delta implies.

Of course, the quote at the moment is $7.10 - 7.40.

 

Yes, there is a factor in B-S to account for supply/demand. It's implied volatility. If the supply is greater than demand then the option price is pushed down and so is the implied volatility (assuming everything else stays the same).

In other words, implied volatility is nothing more than a measure of supply/demand.

 

I certainly understand how IV is a surrogate for supply/demand of the underlying, but I have trouble seeing how supply/demand for *options* could influence their price more than the price of the underlying. I get that a person/system taking the other side of the trade and seeing a sudden surge in sales would *want* to drop the bid, in case the counterparty has an information edge, but I wasn't aware that transactions fit somewhere into B-S or other pricing models.

My knowledge of options market microstructure is pretty sparse, though, so if you have any suggestions for things to read to better understand factors that can impact intraday option trading, I would appreciate it.

Thanks,
Will