A possible deal with Microsoft (MSFT) or potential sale of its network business has been of little interest to investors sending former smartphone stalwart Research-In-Motion (RIMM) spiraling lower by 18% to levels associated with the Dot.bomb era back in 2003. Sparking the latest outrage, management issued a much wider-than-expected loss of $0.37 per share compared to Street estimates of ($0.08) as revenues of $2.81B fell short of forecasts of $3.04 while reflecting a year-over-year drop of 42.7%.
Additionally and looking forward but not too optimistically, a delay in RIM’s BlackBerry 10, admitted competitive challenges and another forecasted earnings loss for its second quarter, look to be assisting in Friday’s stampede out of shares.
On the option side, pre-report premiums turned out to be a tad conservative despite their seemingly rich IV price tag. The Weeklys June contract which expires this afternoon and the purest earnings play available with less time on the clock for extraneous factors to impact shares, priced today’s post earnings reaction or the expected move with a 68% or 1SD chance RIMM would remain within roughly 16% of last night’s close based on eye-balled surrounding money implieds of 260%.
At the same time, the nearly dead on-the-money Weeklys June 9 straddle fetched $0.99 mid-market. That implies, without getting into the other implieds, a breakeven of about 10 on the upside and 8 on the downside. With shares at 9.13 as of last night’s close, the percentage moves required for the straddle to breakeven work out to about 9.5% and 12.3%.
Are you wondering what the source of this apparent difference in percentages is when comparing expected moves using implieds off the surrounding money straddle and strangle markets versus a simpler, but rock solid break-even calculation based on the price of the ATM straddle? The discrepancy has to do with the theoretical concept of continuous hedging of deltas versus looking at the straddle as an expiration position with no hedge and only a profit and loss based on where shares are at that point in time.
The former and more sophisticated strategy aims to use stock movement prior to expiration and all those sometimes fun jumps and other times frightening dumps, to its advantage by flattening out deltas during such moves and continuing the process as other similar moves might occur before the final whistle or in this case, Friday’s expiration closing bell signals that time is officially up for the straddle.
If traders are making “continuous” scalps to flattening deltas from the straddle as they shift in sympathy with further movement in the underlying, it stands to reason a larger “percentage” basis tied to its calculated expected move is reasonable versus the dollar cost break-evens of a straddle.
In truth, a straddle market and an expected move based on implied volatility aren’t one in the same but they are closely-related and after the same objective. That said and in the real world where continuous hedging isn’t always possible, that factor can either be a benefit or a detriment to the expectations surrounding the expected move analysis. And that of course or should be recognized, also depends on whether the trader in question is long premium or short it—and happier with the latest hedge or not.
Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.
