Contrarian traders, by nature, tend to fade the prevailing
market norm. According to some, when the options market gets too
bearish one should get bullish. This is in line with the old theory
that the market tends to punish the greatest amount of people
When options gets overly bearish, the relative price of an 'out
of the money' (OTM) put is pumped up compared to a similar
probability OTM call: the skew is increased.
Perhaps the most interesting underlying optionable asset is
). Shares have slid over 25 percent from their all-time high, and
questions over Apple's valuation is also getting heated. Moreover,
Apple options volume surges before earnings; thus, Apple is a
perfect candidate to test the idea of options skew.
In order to test options market sentiment, Benzinga went back
eight earnings reports and gathered data on weekly 34 delta Apple
The 34 delta options were chosen because prices between the two
options represent a one standard deviation range -- a 68 percent
chance Apple expires between the two strikes.
If a 34 delta option was not listed, the closest option to 34
deltas was chosen. These two options have a similar probability of
expiring 'in the money' (
), but they are selling for two different prices.
The data is presented in the following excel sheet. The sheet
outlines the price of a 34 delta OTM put & call, the quotient
of the prices, and implied volatilities.
Any number over one in the quotient column represents the skew.
These prices should more of less be the same, for the probability
of an up move versus a move down is the same in random walk and
option pricing models.
Skew can be a function of sentiment or what is called an "index
Apple can almost be considered an index because of its massive
weighting in portfolios, another reason why it was chosen. Managers
tend to sell OTM calls and buy OTM puts on indices in order to
hedge their portfolio. The result is index skew.
Another reason why this exists is simply because of human
nature. Investors tend to be more fearful of downside rather than
upside. This is consistent with the given prices. One explanation
could be that Apple is a massively held stock and thus it sees the
"index phenomenon" where calls are cheap because of overwriting
(selling) and puts are expensive because of hedging (buying).
This is backed up by the data, for AAPL is held in large amounts
by mutual and pension funds -- not to mention retail -- more than
any other stock.
The correlation coefficient between the earnings move and skew
was 0.04. This figure is negligible because of its weak nature. A
coefficient over plus or minus 0.80 is considered rather
Considering the relationship was near zero, there is not a
correlation between Apple's earnings move and skew. This is not to
say that contrarian trading does not work. In this instance, it was
just not supported by the data.
(c) 2013 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.
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