Research In Motion (RIM) is a favorite amongst many active traders because of its volatility, however that action comes with a price.  As the market anticipates a move in a particular security the “anticipated” move in that security is reflected in the implied volatility of the option contracts. This raises the asking price, forcing the option trader to dig a little deeper into their pockets to participate in a move.

If I were looking to participate in a possible continuation to the upside for RIM, I might consider purchasing a call option. The question is, how do I know if the options are expensive in relation to the stocks price fluctuation? One way is to compare the stock’s historical volatility to the current implied volatility of the desired option contract. This information can be found in the option chains found on the MX’s site.  To view a snap shot or where to find the information, click on the link below.

RIM OPTION CHAIN 

As I write, the 30-day historical volatility of RIM is sitting at 31%.  If I was anticipating a continuation higher for RIM over the next few months, I might consider a  March 62-strike call. With RIM at $61.88, this would be an “at-the-money” option.

The option is currently trading at $5.40 with an implied volatiltiy of 42%. This suggests that the market feels that RIM is going to become more volatile than it is currently.  It is important to note this increase in implied volatility suggests a possible move in either direction.

One way to offset the cost of an option with a high implied volatility is to create debit spread. The measure of the implied volatility of an option contract is called the VEGA.

For example:

A long call has a positive vega       + 1 March 62 call  $5.40,  vega + 42
A short call has a negative vega     -  1 March 72 call  $2.00, vega  - 41 

If implied volatility drops, you have reduced the impact on the position . The short call benefits from a drop in implied volatility offsetting the negative impact on the long call.

The net cost of the trade is reduced to $3.40, the vega or “implied volatility”  measure has been reduced to +1.  The maximum profit is the spread minus the cost (10-3.40)  = $6.60.

Remember that the spread would have to be held until expiration to achieve the full profit.  While this strategy does require a certain amount of time to pass by (plus a move higher in share price) The debit spread is still at risk of expiring worthless if the move does not take place with in the specified time frame and should be managed accordingly.

All the best

Jason