Monday, June 14, 2010

ONE COSTLY MESS- News Sentiment and Option Volatility

This oil spill is like a vortex. Ruins everything it touches. Coastline, jobs and companies, you name it. Like the spill itself, it casts a dark shadow over the market. What the spill is doing is affecting market sentiment and not in a good way. We can now actually measure market sentiment (I use News Analytics from RavenPack) and create a number from it and combine that number with other market data.

APC 6-11 Sentiment Small w-legend

News Sentiment Scores are measurable and so are changes in Implied Volatility. The landscape above sets up that scenario.

What I am looking at is a pyramid of News Sentiment in an AlphaVision™ Landscape. The skinny tall red buildings are scoring news stories with the lowest News Sentiment Scores for each group. I have defined each group as the change in volatility over the last 3 days of the 2nd (July) expiration month for the At the Money options. The group on the lower left is the decile that had the biggest up move in Implied Volatility over the last 3 days (from yesterday's close). For bad news and volatile market action Anadarko Petroleum (APC) stands out.

This activity has pushed up implied volatility across the board in APC. The ATM July volatility exploded from the mid 70's to the 90's. This movement has pushed the volatility up in the Jan 2011 leaps well to mid 60's. The news that APC owns (but did not drill) 25% of the leaking well made this happen. Bad news can drive and sustain very high Implied Volatilities.

I can't help but think there is an opportunity in this mess but it will take a while for APC's liability exposure to sort itself out. The higher Implied Volatility levels on the Jan 2011 leaps interest me most for a longer term buy write with the expectation that APC's role in this problem diminishes (APC did not drill the well but owns 25% of it). The outer month Implied Volatility should come down to lower levels (the farther terms' volatilities are already starting to slide down as of today). There is still significant risk (and reward) here, but this could be an opportunity.

The opinions expressed by the author are his alone, and do not reflect the opinions of Aqumin LLC, its shareholders, partners or affiliates.