SOLF - Call Purchases with Reverse Skew

Discussion in 'Trading' started by livevol_ophir, Jan 6, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    SOLF is a $260 million solar company in China. Note that vol is up with stock up.

    The company averages 1,485 option contracts a day - in the first 90 minutes over 16,000 have traded. The calls have traded 10:1 to puts. Further, the Net Deltas and Net Premium are substantially positive - indicating purchases of options and net long positions.

    The most active trades: Jan 7.5, Jan 10, Feb 10 and Feb 12.5 calls. Note the Feb calls are opening.

    The Chart illustrates four things:
    (1) The price increase of late.
    (2) The implied vol increase of late - IV30&38482 (red line) vs HV30&#8482 (blue line).
    (3) The high level of option volume (height of volume bar) and
    (4) the propensity of opening order customer call purchases

    Note this is a stock going up with vol also increasing. Volatility skew is the shape of the vol curve in a month going across strikes. Normally this is a downward smile (or smirk) - Lower strikes have higher vol than higher strikes. This is because the investing world (retail, mutual funds, pension funds) are generally long stock.

    (1) They buy puts for downside protection - raising the price (supply/demand) and therefore increasing the vol.
    (2) They sell upside calls for income on the long shares - lowering the price (supply/demand) and therefore decreasing vol.

    This relationship generally holds true. That's one reason why when stocks go down, vol goes up. i.e. stocks go down, people long stock buy puts for protection -> greater demand for options -> higher vol.

    Similarly, that's why vol goes down when stocks move up. i.e. stock moves up -> longs stock sell OTM calls for income -> less demand for options -> lower vol.

    But, for certain types of companies, the demand for upside calls is so great that the skew (vol) heads up for OTM calls as well. Solar companies are a great example. Below you will see my make shift chart of SOLF skew versus IBM skew. The red circles draw your attention to the upside skew in SOLF unlike IBM. Click the image to enlarge it.

    -- Go to the blog to see the charts --

    You can read the details, trades, prices, charts and vol on my blog: