Massey Energy (MEE) - Why Implied Volatility is Important Factor

MEE, an energy company, in recent weeks have come under pressure from the sector sell off. This has been reflected in its shares, which is currently trading at a discount of >30% of its high of ~$95 in Jul 08

IKH, a TA technique recently introduced by a friend and a fellow forummer, Grandrake. I have been intrigued by this tool and have been expensing some time at it.

Base in IKH indicators, I gather the following opinion on MEE.



So, what then of this opinion? What use is it if we simply form an opinion, sit on it and sleep over it? It can only be useful, if we act on them with 2 objectives : 1) Risk Management 2) Profits

It can be said that just about any trades must have these 2 objectives encapsulated, in addition to other trading agenda; which could be hedging or income generation.

As for MEE, one possible option strategy may be to SELL a Call Vertical.

In this case, the following trade can be considered :

SELL MEE Sep 70Call and BUY MEE Sep 75Call for a credit of $1.60
(See analyse of this trade below)



Risk and Profit Potential of this trade :
Maximum loss of $3.40 ( a probability of ~49% of this happening)
Maximum profit of $1.60 ( a probability of ~51% of this happening)

This simply put, means, one is risking slightly a little more than $2 for $1 potential profit. Does not sound like a great proposition, does it ? Indeed, this is not a good strategy.

But more importantly, why is this happening?

The reason is in the current Implied Volatility (IV) of MEE's price action. The current IV is at ~70% as compared to ~95% in late Jun08. As a consequence of a lower IV, the premiums on options have all become "cheaper".

When choosing any SELL option strategies, it is vital to do so when IV is at the HIGH end of the historical volatility.

The reason that HIGH IV is a friend of options sellers, is because of the GREEK VEGA...but we shall leave this VEGA topic for discussion at another time, where it can be demonstrated that VEGA is capable of impact the value of option price significantly.


HENCE, is deploying the below strategy meaningful ?

- 1/+ 1 MEE Sep 70/75Call

IMO, the risk/reward is not justifiable.