Neutralizing volatility

Being in the markets always carries risk, but that doesn’t mean traders shouldn’t take steps to avoid those that are unnecessary. And in options, that means considering potential risks that wouldn’t necessarily be present when trading stocks.

Options traders need to think about volatility and time in ways stock traders don’t. Consider those who may have been watching GIII Apparel (GIII), which was in the upper portion of yesterday’s LiveAction scan for biggest one-week implied volatility (IV) declines. Its 30-day IV was down nearly 46% from the previous Thursday:

The IV contraction followed GIII’s Tuesday earnings release, which featured a 7.4% intraday rally to a one-year high of $31.82 before shares reversed to close lower on the day. Because IV often declines after the uncertainty of an earnings announcement is removed, and lower IV often translates into relatively lower options prices, some traders may have considered buying GIII options after its appearance on the scan.

But the following chart shows there’s a difference between “lower” IV and low IV. Despite the volatility decline over the past week, overall IV for the next four expirations (solid line) was still above the 30-day average (dashed line). That means that while options premiums may have deflated a bit from their pre-earnings levels, they were still far from being underpriced:

That doesn’t mean long-options strategies in such situations are destined to fail, but it may argue in favor of using strategies that incorporate at least some short options. While relatively high IV (and time decay) work against long options, they can provide a tailwind for short options. Long-short strategies such as vertical spreads (e.g., bull call spreads or bear put spreads), can help neutralize these factors.

Meanwhile, GIII’s weekly chart shows the stock put together an impressive rally this year, gaining more than 115% after falling more than 50% in 2022. (The December 2022 low, which was as low as the stock had been since September 2020, followed GIII’s earnings release that month.) As of yesterday, shares were trading above the Street’s average price target of $29.40,¹ and a little more than $5 below its 2021 high of $35.80:

Regardless of whether this week’s earnings turn out to be another inflection point for the stock, knowing whether options premiums may be potentially overpriced or underpriced because of IV levels can help options traders make better decisions about the types of strategies they use.

Today’s numbers include (all times ET): Employment Report (8:30 a.m.), Consumer Sentiment (10 a.m.).

Today’s earnings include: Johnson Outdoors (JOUT).

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¹ TipRanks. G-III Apparel Group (GIII) Stock Forecast & Price Target. 12/7/23.