You would think the move in Arena Pharmaceuticals would mean a windfall for options traders.
But despite massive call buyinga curious thing happened in the options pits: many people lost money.
How could that be?
Well, the explanation is technical, but it does provide a telling warning about the dangers of buying out-of-the-money options heading into catalysts.
Some quick history: since April, the stock has rallied some 400% as investors bet the FDA would approve its obesity drug. That run up caused a spike in the stock’s so-called implied volatility, a fancy term for the price of puts and calls. However, once the FDA made its ruling, that uncertainty was resolved. And as a result, Arena options prices fell faster than the stock rose.
Look no further than the August 10-strike calls.
On Tuesday, with the stock trading at $9.00, those calls costs $2.00. Now the stock is trading for $11.10, but those same calls are five cents cheaper.
So what gives?
Well, for one, the implied volatility on those Arena options fell from 180 to 88.
“Buying options when implied volatility is very high into a known catalyst can often yield very disappointing results,” said CRT Capital’s and CNBC's "Options Action" contributor Mike Khouw. “Once the news is out, there is little reason to believe that the volatility will continue. After all, one can’t defuse a bomb that has already gone off.”
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