Condor Options

So, option activity in Procter & Gamble (PG) has been extremely high for days now, first ahead of earnings, and now in advance of their merger with Folgers.  The stock is 16% off its recent lows, and has been unusually volatile over the past two months along with the rest of the universe.

The interesting thing here, though, is that with all this unusually high option activity, you might expect implied volatility to be hitting new highs as well.  But as you can see from the chart below, implied volatility (the solid red line) actually peaked two days before earnings, and has been falling since then.

That’s actually consistent with the possibility that much of this volume is just traders working the pending merger – especially since activity is high in both puts and calls.  But notice that 30-day historical volatility is still quite high.  What if you were of the opinion that the stock action – the realized or historical volatility – and the volatility implied in the options are likely to converge over the next few weeks?

The Thesis

It’s more common to be looking for this sort of convergence when the situation is reversed: options will get bid up ahead of earnings, for example, and the backward-looking HV reading obviously won’t register the coming move, so you can bet on a convergence by buying straddles.  Even though you’re technically “overpaying” for the options and will get hit when IV declines post-event, the rising stock volatility will often make up for it.

But here, the situation is obviously reversed: the big gap has HV much higher and options pricing in relative tameness.  So as counter-intuitive as it would be to become a net seller of options here, that may be exactly the right play.  If the stock does resume the sort of boring drift that usually plays out after earnings, those already “underpriced” options will get even cheaper.  And the macro environment is on your side as well – obviously a lot of the big swings in the stock price have had to do with bigger picture events, and as the worst of the panic now seems to be behind us, chances are P&G won’t be whipped around so ferociously going forward.

The Trade

The November PG 65 straddle can be sold for about $4.40:

-1 Nov PG 65 call for $1.75
-1 Nov PG 65 put for $2.65

Now, there are only 15 days left in the November expiration cycle, so you’ll be dealing with some pretty serious negative gamma as the trade progresses.  You could hedge with some OTM puts & calls to turn this into an iron condor, or just be prepared to defend the trade with stock to stay neutral.  Even though the implied volatility is well off its October highs, 49% ATM vol is still pretty dear for this stock, so in some sense this is just a play on a return to relative normalcy.

Standard disclaimers apply: bonus trades are provided for the entertainment of the easily amused and the edification of no one.  Only dare to consider this trade if you are also foolish enough to drink Folgers “coffee.” In perusing the internet, as in life, you get what you pay for.