Puts Impl. Vol too high, Call Impl. Vol too low

Discussion in 'Options' started by cqm, Feb 9, 2012.

  1. cqm


    Hello, lets use this hypothetical situation

    The puts implied volatility is too high, the calls implied volatility is too low. I need a strategy to take advantage of this situation if I see it in the future, when there is no catalyst event.

    I am looking at some old data for linkedin after IPO. Pretty much everyone was pessimistic and shorting costs 100% APR at the time, when shares were just becoming available to short 5 days after IPO.

    When the options started trading, the puts in one series were 70% impl. vol ATM, and the calls were at 53% impl. vol ATM

    The puts cost twice as much as the calls then. Lots of juicy premium to be had.

    I want a strategy that basically banks on theta and volatility decreasing or normalizing.

    This would basically involve selling the puts and buying the calls, but this isn't direction neutral enough for me.

    Is there some kind of triple legged spread for this situation? selling a long dated straddle worked well in the backtest, but I want something that counts on the impl. volatility normalizing between the two sides of the book

    and 70% impl. vol is way too high when there is no catalyst event and the vix isn't through the roof.

  2. The arb-premium (hypothetical, as no shares were available) was how you would price the borrow. The swaps and synthetic were trading $2 under nasdaq. If you can't borrow the shares then you can't effect the reversal.

    You can sell OTM puts with the expectation that shares will become available and the vols will trade flat at the strike, but no shares are available. The synthetic short is trading $2 lower... no arb, no edge.

    What you're asking is analogous to seeing a 30-vol on 10D SPX puts and asking how to arb it against 20-vol ATMs. There was a lot of TASR available at GS/SLK back when it hit $90 and the ROR was approaching 100% on the R/R, but I haven't seen anything since that's worth the effort.
  3. +1. as usual atticus is dead on. it doesn't matter if in theory something should work if in reality it can't work. this is prob a bad analogy but "the sun is going to blow up but you can't short the earth". and believe me i would be the first one trying to do this if i could but i don't know who my counterparty would be.

    re the IV being "too high". whenever someone says something is too high, low, whatever, that is by definition an option. whenever someone says "the current market price, iv, whatever is X that is by definition a fact".

    i'm not picking on the op saying his opinion is wrong/worthless or anything i'm just saying that what the option market is saying might seem out of sync w/ reality but it is what it is.

    i've seen biotechs trade w/ iv above 300% and heard the option sellers say "i know it's volatile but it won't move that much" then it does and they have a big problem.
  4. Puts "appear" expensive because of the high indicative rate due to borrowability issues. So no reversal possible. You'll "overpay" for any puts you buy to offset the directional risk of the puts you want to short - negating the juice you're chasing.
  5. If your bullish however, you can get long and get some credit for it. (Unless your broker gives you a good rate for you to lend your shares).