I am glad to be trading again!
For several weeks, my market scanning program was returning exactly zero new trade ideas. In other words, all strategies of several types the program supports were being rejected. I am pleased to report that a new strategy has appeared and has been put in action. The idea: shorting the volatility of COF (Capital One Financial Corp.), using the options expiring in March 2007. Let’s talk about some basic features of this stock and its options.
COF is a fairly expensive stock that traded around 77.50 recently. It is fairly liquid. While I was watching the market and putting positions in place, the bid-ask spread in the stock price was 1 cent most of the time, only occasionally widening to 2 cents. However, the prices often moved with a sort of a jump, i.e., from 77.45-46 bid-ask, to 77.47-48 (as opposed to moving to, e.g., 77.46-47), so the true average sum of slippage and spread is probably a bit over 1 cent. This jumpiness is bad when trading the hedge position.
The March 2007 options on COF displayed varying liquidity over time. I am typically interested in options that are somewhat out-of-the-money. For options priced at around 1.50-2.00, the bid-ask varied from very occasional 5 cents to all the way wide at 15 cents, while I was monitoring them. This corresponds to a widening of bid-ask spread in implied vol from about 0.3% to about 1%. The spread of 10 cents, or about 0.6% in terms of implied vol, was most typical. So, it was important to trade carefully.
The main option being shorted had the implied volatility of about 28.5% when the pre-trade analysis was done. I saw the current (realized) volatility at about 23%. An analysis of recent history suggests that, in the longer term in the past, the typical volatility was about 22%.
COF last released its earnings on October 18, 2006. The next quarterly release will probably come around January 18, 2007 and the following one, around April 18, 2007, will occur after the March 2007 options expire. So there is one earnings release between now and the expiration date.
Needless to say (this is beyond the scope of this post), the options traded also pass other criteria - particularly the criteria, comparing the model-based prices to prices seen in the market.
Disclaimer: I hold positions in securities discussed in this posting. This posting is not an investment advice.