Funny Looking Volatility Surfaces

Greetings, options traders and Volbox users!

This is our inaugural blog, and we’d like to begin by tackling a big question:

What can we infer from those “funny looking” options implied volatility surfaces?

If you’ve looked at a few options IVol surfaces, then you may have characterized some of them as boring, interesting, funny looking and/or “what’s going on here?”

How can these surfaces impart information that will help us make trading decisions?

Let’s begin!

First, let’s look at an IV surface that could be described as “boring,” Procter & Gamble (PG):

IVol Surface for Procter & Gamble (PG)

What does this IV surface show?

First, we see a gently sloping surface, with implied volatility declining as the “term structure” of the options extends into the future. This shape is called “backwardation.”

Second, the volatility smile is more pronounced for the short-term options than for the longer-term ones, with slight skew to the put side. This shape is called “negative skew.”

Although no two surfaces are identical, this general shape is often observed, and it indicates an “all normal” situation.

Interpretation: The options market in PG is not expecting any future increases in volatility and this surface may be the equivalent of getting a clean bill of health.

Note, the overall implied volatility level of these surfaces can vary from stock to stock.

For example, compare the PG surface where the volatility is around and below 20% to that of Barrick Gold (GOLD) where IV does not drop below the 30% level:

IVol surface for Barrick Gold (GOLD)

GOLD has the same overal shape as PG, but the entire surface is shifted “upward” to a higher mean implied volatility throughout.

Next, let’s look at something more unique. 

Consider the IV surface shape before an earnings announcement, such as the surface for Fedex Corp (FDX):

IVol surface for Fedex (FDX)

Here we see a dramatic “cliff” shape in the near-term options contract that expire 20 September (5 days from today).

This high IV is likely caused by the market anticipating an earnings announcement.

FDX earnings are scheduled for release on 19 September, which is why the options that expire right after the announcements are trading with a higher IV.

Remember that the amplitude of the “earnings ridge” can vary from stock to stock: securities that have historically had more predictable earnings will have lower ridges than those securities that in the past have had highly volatile earnings.

A ridge is not necessarily related to an earnings announcement; other expected events can cause higher IV.

The important point is that whenever you see a ridge, you need to do a little digging and try and find the cause.

Knowing what’s expected will lead to better informed trading.

Next, here is an unusual surface that may cause head scratching, Artisan Partners (APAM):

IVol surface for Artisan Partners Asset Management Inc (APAM)

This surface is drawn from a very limited number of options.

Some securities’ options have a minimum of expiration dates listed and few strike prices available.

The IV surface is constructed using this small data set and may not be the most useful.

In these cases, looking at the Scatter plot, which graphs the actual IV of contracts used to create the surface, may confer more valuable information.

IVol scatter plot for Artisan Partners Asset Management Inc (APAM)

Finally, Cassava Sciences (SAVA) is a stock with a truly unusual surface showing a steep IV “wave” in December 2024.

IVol surface for Cassava Sciences Inc (SAVA)

A little investigation reveals that this pharmaceutical company has not generated any revenue to date, which means that any new information (good or bad) may have a notable affect on the underlying stock price.

A further look on the company’s web-site leads us to a press release containing the following information:

Cassava is currently running a double-blind, randomized, placebo-controlled study of simufilam in patients with mild-to-moderate Alzheimer’s disease dementia. The Company expects to announce top-line results of this study by the end of 2024. 

Big news expected! This could be a make-or-break event for this company and the market is expecting a major spike in volatility.

Finally, an important note: Looking at a stock’s volatility surface will not tell you to “Buy this call” or “Sell this put”.

But, the vol surface will show you when higher volatility is expected.

An unusual surface should be interpreted as a red flag and an indication that some further research is warranted.

Know your options with Volbox, and don’t forget that the first month is free!