2

I had purchased 3 puts of MNOV yesterday with a strike price of 7.50 when the stock was worth around $11 and it raised as high as $13+

The stock price had dropped as low as $7.15 and is currently worth $7.20 but I’m showing a negative balance. Can anyone explain why and what I could’ve done differently?

Expires Aug 21st

Improve this question
1
  • if the option is a 7.50P, and spot is 7.20, you are in the money and the option has value. It also has optionality as the exp is next month. This should not be a negative mark to market. Unless it's been marked by a moron or some crappy broker that also charges you fees. Is the option American or European style?
    – Woodstock
    Jul 28 '20 at 20:31
2

I assume by "negative balance" you mean a loss from your purchase price. The puts still have positive value.

The implied volatility of MNOV collapsed today. I don't know the latest company news, but it appears that the developments leading to Monday's surge in the stock are now somewhat reversed, in the market's perception. As of Monday, risk was believed to be very high on both the upside and downside. The stock rose, but people (including you) were also paying high premiums to protect against a crash.

A possible coherent explanation for today is that, in the market's view, much of the upside risk went away (leading to a sharp drop in the stock) but also some of the downside risk went away (so a further drop is now seen as less likely). This is unusual behavior. It is more often seen with earnings announcements, where a moderate disappointment can both tank the stock and reduce the value of lower-strike puts because a disaster scenario is taken off the table.

The lesson is to beware of elevated implied volatility when buying options. This can be mitigated by buying in-the-money options, which are less sensitive to implied volatility: Higher-strike puts on MNOV did gain today.

Improve this answer
6
  • are you saying that his negative balance is the ITM option - the premium he paid for the option?
    – Woodstock
    Jul 28 '20 at 20:48
  • @Woodstock Yes, that is the number (P/L) that would be negative, but isn't typically the "balance" (account value) because long options are paid in full, i.e., the premium came from cash he already had.
    – nanoman
    Jul 28 '20 at 20:56
  • Right, so it's a long time since a worked in pricing exotic options, however, I'm pretty sure since this was probably priced with black-scholes, and it was a deeply OTM option at the time of purchase, despite the implied vol the prem would have been very little. Also who looks at premium costs for vanillas when marking to market?
    – Woodstock
    Jul 28 '20 at 20:58
  • @Woodstock I am assuming that OP saw a negative P/L displayed in his account and is imprecisely referring to it as a "negative balance".
    – nanoman
    Jul 28 '20 at 21:05
  • Correct, I’m currently showing a balance of -11% and am down $45 of my initial $405 investment. I went on robinhood to check the IV and noticed that it dropped from 280+ yesterday to 145% today. I checked on a long call calculator and see that it would need to drop to around $6 before I see profits. I certainly should’ve purchased an in the money option yesterday like you suggested Nanoman
    – Luigi
    Jul 28 '20 at 21:15
2

Per your question and subsequent comments:

When implied volatility increases, so too does time premium. And conversely, it contracts when IV decreases. With an IV of 280%, your puts were incredibly expensive.

If you input all of the variables into an option pricing model, what you experienced was normal. IOW, with a share price drop of $3.80 along with an IV contraction from 280% to 145% would result in about a $15 loss per put.

What could you have done differently?

  • Buying 280% IV options is an invitation for disaster. Your trade could still work out nicely if MNOV continues to drop but at this point, a $3.80 share price drop with no gain is a lot of wasted market move.

  • An alternative is to sell some expensive premium to offset overpaying for the long leg. A vertical spread at the same $1.35 cost per spread would have provided a profit today. Obviously, that result is better today but would end up performing worse than your long put if MNOV dropped a lot more.

Improve this answer
2
  • Hey Bob, I really appreciate the breakdown. I honestly didn’t realize that IV played a role in the price of an option. I mean, I feel silly for not realizing it as it clicked the moment I read your response. I genuinely appreciate the info. That all made perfect sense. I’ve been wanting to learn more about debit/credit spreads, but I don’t quite understand it yet. I will definitely be doing much more research so I can avoid being in this situation again and maybe covering my put with a debit/credit spread in the future. Again, thank you and everyone else that helped alleviate my confusion.
    – Luigi
    Jul 29 '20 at 12:03
  • @Luigi - You're quite welcome. IV is one of those things that unfortunately, most people learn about later on. Each option strategy has is advantages and disadvantages and the selection depends on one's outlook (hope?) for the underlying as well as one's risk tolerance and reward goal. Which strategy is best depends on what you're trying to achieve and the respective trade offs. If you really want to get a handle on options, pick up a copy of "Options as a Strategic Investment" by Lawrence McMillan. there are other good books but AFAIC, this is the 'go to' one.
    – Bob Baerker
    Jul 29 '20 at 12:20

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.