I know weekly expiration cycle's Implied Vol. explodes prior to earnings, that is due to Theta and Expected move. But why does it happen on stocks that don't have earnings? ( let's say earnings will be in 60 days)
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1$\begingroup$ 1 What stock? 2 How do you calculate your time to expiration? $\endgroup$– onlyvix.blogspot.comCommented Jun 25, 2016 at 13:26
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$\begingroup$ 1) It doesn't matter what stock. For the sake of simplicity take AMZN and watch for IV differentials in expiration cycle. 2) What do you mean by how do you calculate time to expiration( it is given to you) $\endgroup$– IzzyCommented Jun 25, 2016 at 17:33
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2 Answers
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One reason short term IVs pop could be a sector-related factor, such as an important number coming out that affects for example financial stocks. Short term options have really high gamma, so can make for a good short term leveraged play.
Another factor might be that deep out of the money options often get a bid of nearly zero, but people don't like offering teeny options for nothing, so they might just use a minimum price level for the offered price like 0.01, even if this is far higher than a rational value would be, based on a "sensible" implied vol. The implied vol calculator probably is then taking a mid-market value, and as short term options have very low vega, you need a very high implied vol to get to that mid-market price.
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RiskyScientist answers make sense, but I want to provide a counter-example and an alternative, more systematic answer.
If you look at ATM weeklys on SPY/SPX you will also see volatility rises into expiration as well. This behavior cannot be explained by sector-related, or any idiosyncratic reason. Also ATMs are highly liquid, and are prices far above 0.01, so RiskyScientists second reason would also not apply here.
The reason why there's an IV premium for short-term options is because they are cheap in $ - so you can get a lot of gamma for little money, either for speculation or to hedge something longer-term flow for cheap.
answered Aug 2, 2017 at 12:58