Taking the hint from volatility

  • Lululemon (LULU) has traded sideways the past couple of months
  • Implied volatility (IV) higher than recent historical volatility (HV)
  • HV-IV “disconnects” can highlight possible price breakouts

Novice traders tend to expend a lot of time and energy searching for some type of crystal ball—maybe an indicator, trading system, guru, or collection of tea leaves—that will allow them to consistently predict the future.

Those who have been in the game a while know that the best you can do is take action when you have an edge, and control your risk.

That edge can take different forms, but one way to identify potential price moves is to look for stocks that currently aren’t moving much, yet have options that are suggesting they could do something in the near future. What we’re talking about here is comparing historical volatility (HV, how much a stock has moved during a certain past period) and implied volatility (IV, how much options traders expect the stock to move in the future).

LiveAction scan: 30-day HV < 30-day IV, 3/13/19. Options volatility high, price volatility low

Source: Power E*TRADE

Consider this Power E*TRADE LiveAction scan from yesterday showing stocks with 30-day HV below their 30-day IV (above). What this scan is telling us is that options traders are factoring in the potential for increased volatility in the next 30 days (high IV) relative to the amount of actual price volatility that has occurred over the most recent 30 days (low HV).

In other words, there appears to be a possible disconnect: Price volatility is saying “not much happening here,” while options volatility is saying “hey, something could happen here.” Athletic-wear brand Lululemon (LULU), for example, had IV almost twice as high as its HV yesterday morning. The following price chart shows that, other than a pop in the middle of February, LULU shares have been moving sideways since January 18, and the stock recently tested (and bounced off) the bottom of this range:

Lululemon Athletica (LULU), 12/12/18–3/13/19. Lululemon Athletica (LULU) price chart. Mostly rangebound.

Source: Power E*TRADE

One thing to keep in mind is that imminent earnings releases and other potentially market-moving events can produce big spreads between HV and IV: Stocks often have very low price volatility (i.e., they trade very quietly) in the last few days before an earnings report, while options IV is very high because of the expectation that any surprise in the numbers could produce a big price move. Happens all the time. (In fact, several of the stocks on the LiveAction scan were scheduled to release earnings within the next few days, and so had higher IV than HV.)

LULU, however, isn’t currently scheduled to release earnings until March 27—exactly two weeks from yesterday. The stock could continue to trade sideways until it posts its numbers, but it’s also possible the HV-IV disconnect may point to a possible price move in the interim.

You can also plot HV and IV directly on a price chart to see how a stock has responded to big discrepancies between the two over time:

Lululemon Athletica (LULU), 10/28/16–3/13/19. Lululemon Athletica (LULU) price chart. HV and IV over time

Source: Power E*TRADE

It’s impossible to know exactly when a big price move will occur—or its direction—but you can improve your chances of finding potential opportunities by keeping tabs on when stock traders and options traders have different opinions about volatility.

Market Mover Update: Yesterday Match Group (MTCH) put together its third straight up day since last Friday’s 23-day low (see “Looking for love”), while Apple (AAPL) hit a three-month high. Also, tech overtook industrials as the S&P 500’s (SPX) best-returning sector of the year (see “Tech’s turn?”). April WTI crude oil futures (CLJ9) traded above $58/barrel for the first time since November 19.

Today’s numbers: Import and Export Prices (8:30 a.m.), New Home Sales (10 a.m.), EIA Natural Gas Report (10:30 a.m.).

Today’s earnings include: Dollar General (DG), Adobe Systems (ADBE), Broadcom (AVGO), DocuSign (DOCU), Huazhu Group (HTHT), Jabil (JBL), Overstock.com (OSTK).


Click here to log on to your account or learn more about E*TRADE's trading platforms, or follow the Company on Twitter, @ETRADE, for useful trading and investing insights.

What to read next...

…in all the appropriate places. After pulling back for the past month, will Match Group find traders are ready to “swipe right?”

Airline stocks lose altitude on Boeing downturn, but is it just minor turbulence?

Tech holds up best as market retreats from resistance.

Looking to expand your financial knowledge?