Chart of the Day – LinkedIn Options Ahead of the Facebook Mania

by Enis May 17, 2012 7:33 am • Commentary

So I heard there was a Facebook IPO this Friday.  That’s the advantage of being a professional trader.  You get the information first.

Kidding aside, LinkedIn is probably the most closely related public company to Facebook.  And if you were not aware, options on Facebook are supposed to start trading on May 29th.  Options on Facebook will almost surely be the most actively traded options in June, and likely remain one of the more actively traded names in the whole options market for the balance of the year.  Naturally, I was curious, how do LinkedIn options look?

Today’s COTD is really several charts.  First, the LinkedIn stock chart is a volatile portrait, but it’s near all-time highs (granted, on about 1 year of history), steadily rallying into the Facebook IPO:

The stock fell about 50% from its Jul 2011 highs (not including the first day post-IPO trading), and then has more than doubled from those Nov 2011 lows, quite a round trip in 10 months.  When I looked at the options pricing, the implied volatility seemed fairly priced, but what struck me was what had happened to the options skew over the last month.

For those unfamiliar with skew, it basically refers to the implied volatility difference between the lower strike puts and the higher strike calls.  Here is Kristen’s educational primer for further reading.  In LinkedIn’s case, the downside puts have significantly richened relative to the upside calls in the past month, illustrated by 2 charts.

The first chart is how the 2-month options skew looked one month ago.

The second chart is how the 2-month options skew looks today:

As you can tell, the skew today is much steeper than the skew one month ago.  The easiest way to see that is to compare the implied volatility difference between the 90 and 120 strikes one month ago (about 4 points, the difference between 56.5 and 52.5) and today (about 12 points, the difference between 65 and 53).  So the downside puts are much more expensive relative to the upside calls today, and that offers some good risk/reward opportunities for trades.

For example, if you want to bet on a selloff in LinkedIn, here are a couple trades that take advantage of steep skew: 

-Buy the June 105/95/85 put fly for $1.35.  Buy 1 105 put, sell 2 95 puts, buy 1 85 put.

-Buy the June 100/95 put spread for $1.00.  Buy 1 100 put, sell 1 95 put.

If you want to play for a continuation of the rally, here is a trade that takes advantage of steep skew:

-Buy the June 130/95 risk reversal for $0.10.  Buy 1 130 call, sell 1 95  put. 

Regardless of your view, it’s valuable to check for relative pricing discrepancies of options when choosing  your trade structures.  Without analyzing the whole options surface, your options trading foundation will be built on stone instead of steel.