Right forecast, wrong trade

  • BYSI fell more than 30% in one day last month
  • Stock rallied nearly 10% over the next three weeks
  • Were calls or puts a better tool for capturing the rebound?

The idea behind “Options discount check”—that buying “inexpensive” options or selling “expensive” ones involves much more than the underlying market’s price—is reflected in a nasty reality of options trading: You can be spot-on about a market’s direction and still lose money if you buy an option that’s too expensive or short one that’s too cheap.

A good example unfolded in recent weeks in biopharma stock BeyondSpring (BYSI), which dropped 33% on September 20, falling from $22.91 to $15.36:

Chart 1: BeyondSpring (BYSI), 9/14/21–10/26/21. BeyondSpring (BYSI) price chart. Rallied 9.6% between Sept. 20 and Oct. 14.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)

Since then, the stock’s highest close was $16.84 on October 14—a $1.48 increase that represented a not-insignificant 9.6% gain from September 20.

Now take a look at the following chart comparing the BYSI November $15 call (top) and November $15 put. On September 20, the $15 call was slightly in the money (strike price below the stock price), while the $15 put was slightly out of the money (strike price above the stock price):

Chart 2: BYSI November $15 calls and puts, 9/20/21–10/26/21. BeyondSpring (BYSI) options price chart. Short put returned more than long call.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)

Let’s say a trader expecting BYSI to rebound over the next few weeks bought the $15 call on September 20 when it was trading for 3.4—which may have seemed like a good deal, given the option had dropped 64% from the previous day’s close of 9.35.

But the chart shows that on October 14 the $15 call closed at 3.6—just 0.2 higher than on September 20. Contrast that nominal gain to the move in the $15 put, which a trader could have shorted on September 20 for 3.0 and bought back on October 14 for 1.59 for a 1.41 profit—almost as much as the stock’s absolute gain during this period (and much bigger on a percentage basis).

The lesson: Traders who expected BYSI to rebound after its September 20 sell-off turned out to be absolutely correct, but they also could have failed to capitalize on that forecast by trading an option that had two things going against it:

1. Volatility. The big sell-off temporarily inflated implied volatility (IV), which in turn temporarily inflated the option’s price. Volatility subsequently declined as the stock moved mostly sideways over the next few weeks, removing that boost to the option’s price.

2. Time: Because they have fixed expiration dates—after which they have no value—all options lose value over time, regardless of all other factors.

In this situation, bullish traders who instead shorted the $15 put had time and volatility working in their favor, since a decline in IV and the passage of time both eroded the value of the option that they could buy back later at a lower price.

In a different situation—say, when volatility is low, and time is less of a factor—buying an option may be the more appropriate choice. But when using options to make a directional trade, you can’t just think about whether you expect the underlying market’s price to go up or down, you also need to decide whether you think volatility is going to go up or down, and to what degree time will be working for you or against you.

Wednesday’s numbers include (all times ET): Mortgage applications (7:00 a.m.), Durable Goods Orders (8:30 a.m.), Advance International Trade in Goods (8:30 a.m.), Advance Wholesale and Retail Inventories (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.).

Wednesday’s earnings include: Apple (AAPL), O'Reilly Automotive (ORLY), Bristol-Myers Squib (BMY), Boeing (BA), eBay (EBAY), Shake Shack (SHAK), Teledyne (TDY), Xilinx (XLNX), Upwork (UPWK), Spotify (SPOT).

Wednesday’s IPOs include: Informatica (INFA), Arteris (AIP), Rent the Runway (RENT).

Thursday’s numbers include (all times ET): GDP (8:30 a.m.), Weekly Jobless Claims (8:30 a.m.), Pending Home Sales Index (10 a.m.).

Thursday’s earnings include: Amazon.com (AMZN), Yum! Brands (YUM), Merck (MRK), Caterpillar (CAT), Starbucks (SBUX), Northrop Grumman (NOC), Keurig Dr. Pepper (KDP), Eagle Materials (EXP), Mastercard (MA), Shopify (SHOP).

Thursday’s IPOs include: Solo Brands (DTC), Ensemble Health Partners (ENSB), LianBio (LIAN), Candela Medical (CDLA).


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