Evidence of Call Options Getting Even More Expensive

by Jon C. Ogg

Stock Tickers: AAPL, TWX, GOOG, RIMM, XOM, DNA, SPY

The CBOE Volatility Index ("the VIX") has gotten off the sub-10 readings, but it is still extremely low around 10.75.  The chart enclosed here will show you that this is at lowest levels since it has been tracked.  Just because the VIX is low, that doesn’t mean all options are cheap; but put options are generally far cheaper than call options right now.

In a Bull Market it is easy to figure that Call options are more expensive and more active than Call options.  Most in the Wall Street crowd will refer to volatility, and will go into the Greek terms (many left off intentionally):  Delta, or the Hedge Ratio or Hedging Ratio, where underlying price changes in an asset are correspond to derivative (options) price changes.  Gamma, the rate of change for delta based on underlying asset’s price.  Theta, the rate of change with time sensitivity.  Vega, the rate of change between an option’s value compared to volatility; Vega is very important for event-risk ahead of certain FDA events, earnings, mid-quarter updates and the like.

Look at actual snapshot pricing of options for highly active and highly liquid stocks.  Right now Call options are more expensive than put options, and not by a small margin.  Because no one is really scared and every investor on the street is happy it is dirt cheap to buy downside protection for stocks by purchasing puts, and as we have been in a bull market the call options are comparatively more expensive by far.

View the following prices based on static prices:

Apple (AAPL) at $92.28…..on AAPL these don’t look grossly different until you go farther out.
AAPL JAN07 $95.00 CALLS $4.40
AAPL JAN07 $90.00 PUTS  $4.10
AAPL APR07 $95.00 CALLS $8.10
AAPL APR07 $90.00 PUTS    $6.70

Google (GOOG) at $506.10….even if you back out the entire $6.10 intrinsic value and directly swicth it there is still an extra 40% call-bias premium.
GOOG JAN08 $500 CALLS $84.00
GOOG JAN08 $500 PUTS $52.00

Time Warner (TWX) at $20.50…..TWX is $0.75 from the mid-point, or more than 3% stock gain yet the Calls are the same price.  This option is arguably 35% more expensive.
TWX JAN08 $22.50 CALLS $1.15
TWX JAN08 $20.00 PUTS $1.10

Research-in-Motion (RIMM) at $141.40….RIMM is closer to the $140 strikes by over $1.00, so the RIMM Calls are about 15% to 20% more expensive than the puts.
RIMM JAN07 $145 CALLS $8.60
RIMM JAN07 $140 PUTS $8.70
RIMM MAR07 $145 CALLS $12.60
RIMM MAR07 $140 PUTS $11.70

Exxon Mobil (XOM) at $72.54…this is key because it is almost perfectly between and at strike prices:
JAN07 $72.50 STRADDLE: $2.45 CALL & $1.80 PUT
JAN07 $75 CALLS $1.15
JAN07 $70 PUTS $0.90
JAN08 $75 CALLS $5.90
JAN08 $70 PUTS $3.90
JAN08 $72.50 STRADDLE: $7.30 CALL & $4.90 PUT

Genentech (DNA) at $80.51……even if you back out the intrinsic value of the $51 overage in DNA and use a regressive number for the PUT you can see that the Calls are at least 25% more expensive.  Then look at the incremental out of the money strike prices out over a year and you get what could be a 50% premium or more.
MAR07 $80 CALLS $5.40
MAR07 $80 PUTS $3.60
JAN08 $85 CALLS $8.60
JAN08 $75 PUTS $4.60

Spyders (SPY) at $140.53………even the S&P 500 Index options show this.
JAN07 $141 CALLS $2.25
JAN07 $140 PUTS $1.95
MAR07 $141 CALLS $4.20
MAR07 $140 PUTS $3.30

Part of the reason for this is that investors use options, at least on a trading instrument basis, as tools to speculate that stocks are going higher.  Only 1/4 of the investor base really even knows how to try to profit from a market drop and probably 1/3 of the market doesn’t even know you can try to make money on a falling market.  This isn’t meant as any slight, because hopefully this will help at least a few people on how to recognize when trends and events dictate cheap options and expensive options.

There was also a great article by Nassim Taleb in the March 2006 magazine print issue of Active Trader on using way out of the money put and call options for the long-haul when the market has failed to recognize longer-term specific event risks.

http://activetradermag.com/tocs/toc0306.htm

It usually takes extended periods of fear and negativity for PUTS to be more ACTIVE than calls, or at least so it has always seemed.  I am sure someone has some empircal hard numbers that would prove this wrong from time to time, but the general public and even institutions have tended to look more at call options than put options. 

As noted earlier this week, if you have substantial gains that you want to lock in it looks cheaper than it has been in years to lock in prices or to protect downside.  It is usually hard for most people to stomach paying anything when they see the markets have gone up and up for a few months.  But smart money looks to hedge transactions when it is the cheap to hedge, and right now that is the case.

We constantly look for event-risk and mispricing based on upcoming events.  This is fairly easy to do ahead of earnings on a set date, but gets much trickier when there is just a pending outcome with an unspecified date.  Those are situations we like to look for when it comes to options.  We also look at options as a method of hedging bets for minimizing risks.  We will follow up with put/call ratios next week.

Have a nice weekend!

Jon C. Ogg
November 26, 2006