Volatility showdown

On Monday, a day after Howmet (HWM) hit a 16-year high, the aerospace and defense stock traded modestly lower while appearing near the top of the LiveAction scan for heavy call options volume:

With HWM shares trading mostly between $80-$81 Monday morning, 9,700 contracts traded in the June $90 calls, vs. open interest (OI) of only 33 contracts. HWM options aren’t especially active, which made it easy to see how unusual Monday’s trade was. Only three other options had OI of 1,000 or more: the October $80 call (1,000), the $75 November call ($1,200), and the July $60 put (3,800).

This activity came seven trading days after HWM soared in the wake of its May 2 earnings release. As the following price chart shows, the stock also enjoyed sizable rallies after its previous two earnings releases, in mid-February and early November:

HWM jumped 15.5% on May 2 and tacked on an additional 6% by last Thursday’s close. On Monday, the stock was up nearly 80% since November 1—and also a little above the average Street analyst target of $79.12.¹

While some traders would likely interpret Monday’s call volume as a potentially bullish signal in a stock that has displayed a great deal of upside momentum lately, those with a contrarian bent may draw attention to the other side of the volatility coin:

This “volatility constellation” compares HWM’s options implied volatility (IV) to its 30-day average. Except for May options, which expire at the end of this week, IV was below average for every expiration. In other words, the options market was expecting HWM stock to be less volatile than usual.

That’s worth noting, because a key characteristic of IV is that it represents a forecast of how much a stock may move, not the direction of that move. But if this projection of HWM volatility turns out to be correct—and there’s no guarantee it will—it may give a slight edge to traders who sold calls on Monday, rather than buyers.

That’s because the options sellers could potentially make money if volatility in HWM stock increases (as long as the stock’s direction is lower) or decreases, since the options will expire worthless in 26 trading days (on June 21) unless HWM is trading above $90—roughly 12% above Monday’s levels. In other words, sellers can benefit regardless of whether the stock moves sideways, up, or down.

By contrast, the call buyers holding until (or near) expiration need increasing price volatility—as long as that volatility is to the upside—since the calls would gain value from a rising stock price and also potentially get an additional boost from rising IV.

What remains to be seen now is whether the options market is correct about potentially slowing volatility, or if the stock is going to repeat the bullish-momentum pattern it displayed after its two previous earnings announcements.

Market mover update: The S&P 500 (SPX) didn’t move much on Monday, but the Cboe Volatility Index (VIX) closed higher for the first time since April 30, and jumped more than it has on any day since April 15—a possible sign the options market is anticipating increased volatility on the verge of this month’s inflation numbers.

Today’s numbers include (all times ET): NFIB Small Business Optimism Index (6 a.m.), Producer Price Index PPI (8:30 a.m.), Jerome Powell speaks at the Foreign Bankers’ Association annual meeting in Amsterdam (10 a.m.).

Today’s earnings include: Home Depot (HD), International Game Technology (IGT), Jack In The Box (JACK), On Holding (ONON), Nextracker (NXT).

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¹ TipRanks. Howmet Aerospace (HWM) Stock Forecast & Price Target. 5/13/24.