Capitalizing On Volatility In Recent Spin-Offs

Volatility is always high for recent spin-offs. You can take advantage of that by “selling volatility” in the options market. First, let’s step back and cover how options are priced. Here’s Joel Greenblatt:

In general, professionals and academics calculate an option’s “correct” or theoretical price by first measuring the past price volatility of the underlying stock—a measure of how much the price of the stock has fluctuated. This volatility measure is then plugged into a formula that is probably some variant of the Black-Scholes model. The formula takes into account the stock’s price, the exercise price of the option, interest rates, and the time remaining until expiration, as well as the stock’s volatility. The higher a stock’s past volatility, the higher the option price.

Because spin-offs are extremely volatile in early trading (often to the downside), the pricing of calls and puts will be artificially high in initial trading. As such, there is often an opportunity to sell a put for an attractive implied return.

Alright let’s get into a case study:</