Option activity and trading advice over the past week seems to have been dominated by hedging activity, such as overwriting, buying puts or even replacing long stock holdings with call options. Traders have been trying to take advantage of the recent run-up to secure some profits and reduce risk.
But now that's done and the market has settled down, so it's time to search for some fresh opportunities. Naturally, options traders always gravitate toward high-volatility situations. These provide the action needed to turn short-term trading profits.
One stock with volatility that has shot up is Research In Motion (RIMM:Nasdaq - commentary - research). The stock tumbled some 22% in the last week to an intraday low of $72.19 on Tuesday and has since recovered somewhat, trading above $80 in recent trading Wednesday. The implied volatility (IV) of the November at-the-money options has shot up to 75% from 50% one week ago and is twice where it was 30 days ago.
While the initial catalyst moving Research In Motion was talk of customer dissatisfaction with a new product, the real item pumping up volatility is the impending decision on a patent infringement lawsuit brought by privately held NTP Inc. Whichever way the ruling goes, the stock is likely to make a significant move, because the ramifications are huge.
Research In Motion lost the case the first time in 2002, resulting in an injunction banning BlackBerry sales in the U.S. The injunction was stayed pending the outcome of the appeal, but it's likely to be reinstated if Research In Motion loses. At the time, the company was also required to set aside 8.55% of U.S. sales as a royalty rate for NTP until the case is concluded. Those funds would go back to Research In Motion if it wins the case; that would create the double bonus of a cash windfall and the removal of giant legal question mark.
Even at the current level, I don't think the options have fully priced in the potential move. I expect implied volatility to keep increasing as the judge's decision draws closer and its ramifications come fully into focus.
Therefore I think it makes sense to purchase a straddle in Research In Motion. Getting long a straddle, which is the simultaneous purchase of a put and call with the same strike price and expiration date, is a bet that IV will increase and/or the underlying price will move beyond the cost of the straddle. I think the current situation in this stock offers the possibility of both a substantial increase in implied volatility and a price move beyond the break-even points. Here are the two main challenges:
Justifying paying the current premium. Is there good reason to believe IV can rise further? And will the potential move go beyond the break-even points?
Timing. In most situations IV doesn't perk up until a decision or event is imminent, but there are plenty of situation where "any day" turns into weeks away.
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