Options parts greater than the whole

Traders inclined to ignore implied volatility (IV) and time decay may want to take a look at the relationship between Advance Auto Parts (AAP) and some of its options over the past few days.

AAP jumped on Tuesday after releasing earnings, although it closed well off its intraday high and near the bottom of the day’s range:

Yesterday the stock sold off sharply: Around 11:50 a.m. ET, it was down more than 4%—and, as the dashed line shows, it was also well below Monday’s closing price (two days earlier).

Now, let’s look at a chart of the AAP $139 put option expiring on Friday. As would be expected, the price of the put fell sharply on Tuesday when the stock rallied, and it was higher yesterday morning when the stock sold off:

But yesterday morning the put was also trading much lower than it had been two day’s earlier, even though AAP shares were more than 1% below Monday’s closing price. All else being equal, a lower stock price should translate into a higher put price. Last week, for example, when AAP closed lower each day between February 22-24, the put closed higher each day.

But all things are rarely equal in the markets. In this case, the disconnect was likely the result of a sudden IV decline. Implied volatility often increases significantly before earnings because of uncertainty, inflating options premiums in the process. After the announcement, the uncertainty is gone, IV often falls sharply, and options premiums deflate accordingly. Also, with expiration just two days away, what little time value was left in the $139 put was about to disappear forever.

So, a trader who bought the March $139 puts on Monday in anticipation of a down move would have been staring at a potentially sizable loss on Wednesday morning—even though the stock was trading lower than it had been two days earlier. This example may be a little more pronounced because earnings occurred just a few days before expiration, but it shows why traders always need to be aware of how IV and time decay may impact their positions.

Today’s numbers include (all times ET): Jobless Claims (8:30 a.m.), Productivity and Costs (8:30 a.m.), EIA Natural Gas Report (10:30 a.m.), Vehicle Sales.

Today’s earnings include: Best Buy (BBY), Big Lots (BIG), Anheuser Busch InBev (BUD), Burlington Stores (BURL), Kroger (KR), Macy’s (M), C3 AI (AI), Broadcom (AVGO), ChargePoint (CHPT), Costco (COST), Dell Technologies (DELL), Hewlett Packard Enterprise (HPE), Nordstrom (JWN), Marvell Technology (MRVL), Zscaler (ZS).

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¹ All figures reflect S&P 500 (SPX) monthly closing prices, 1960–2022. Supporting document available upon request.