YHOO options have been very active in the past 2 weeks as speculation surrounding the Alibaba IPO has reached a fever pitch. We discussed a couple of weeks ago the way implied volatility moved as traders moved their expectations for the IPO to late September. Last week, the Sept 18th IPO date was disclosed, and options market makers re-adjusted the Sept20th expiration implied volatility higher to reflect that.
CC noticed today that the skew in Yahoo upside options has reached a very extreme level. (For a primer on volatility and skew, check out our Education section on that topic). In layman’s terms, the upside calls have seen abnormally high demand, so market makers have moved the price of those upside calls much higher relative to the at-the-money calls than is normally seen in YHOO or almost any other single stock. For example, here is the chart of Yahoo’s Sept20th skew (yellow) and Oct18th skew (purple):
The $41 to $45 strike calls get progressively higher in implied volatility terms, which is an anomaly for a single stock option skew structure. Compare YHOO’s skew to EBAY’s Sept20th and Oct18th skew graphs, which are more typical for a single stock:
EBAY’s Sept20th skew is a smile that is typical for very short-dated options, where the wings are higher than the at-the-money since it’s a low amount of premium to start. For the Oct20th skew, the calls are not higher than the at-the-money options for the most part, while the puts have a much higher implied volatility, reflecting the normal expectation that volatility would be higher on the way down rather than on the way up.
In contrast, YHOO’s skew is a reflection both of supply/demand dynamics (heavy upside call buying), and a potential expectation that any major volatility in YHOO over the next couple of weeks is more likely to be to the upside rather than the downside. In other words, Alibaba’s IPO could cause a big move higher, but is unlikely to result in a big move lower.
One trade structure that illustrates the steep level of the skew is the Sept20th 41/43 1×2 call spread, which is around a $0.10 credit. In other words, that trade structure takes in $0.10 if YHOO is at or below $41 on Sept20th expiration. The 1×2 call spread can make up to $2.10 if YHOO closes between $41 and $45 with a max gain of $2.10 if YHOO is at $43 on expiration. The risk, of course, is if YHOO closes above $45.10, where the trade has open-ended downside risk 1 for 1 with the stock.
That is quite rare to have a short-term trade structure with such a wide area of positive profits. It reflects the fact that options traders see more potential for a large upside move rather than a big decline. We just wanted to point out the extreme skew for now, though we are looking at potential trades for the future.