Wednesday, July 18, 2007

Individual Stock Volatility: InterOil Corp. (IOC)

I have thus far resisted the temptation to talk about individual stocks and their associated volatility, but with all the crazy action in InterOil Corp. (IOC) right in the middle of options expiration week, this seems like the perfect opportunity to break the silence.

In a nutshell, the InterOil story is of a massive natural gas find (perhaps 15 trillion cubic feet) with their Elk-1 well, which was announced about a year ago. Current drilling in Elk-2 is ongoing and speculation about the results of these efforts is what is responsible for the extreme volatility in this stock – enough to take the stock down 60% in three days.

I have appended a chart of the implied and historical volatilities below, as well as a current snapshot of the options. To put it mildly, these options offer some unusual and interesting possibilities, given that expiration is only two days away, volatility is sky high, and the likelihood of a significant news announcement during that period appears to be slim. To further sweeten the pot, IOC just happens to be trading at exactly the 22.50 strike as I type this, which makes short straddle, short strangle and butterfly possibilities particularly interesting.

Those thinking about selling volatility for the next two days, however, should give some serious consideration to hedging their exposure by considering an iron butterfly or an iron condor. This is a keg of dynamite, after all, but there is a good possibility it will not go off in the next two days.


Bill Luby said...

For the record, a good summary of the bear case (and shorts are 33% of the float) comes via (aka

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