The SVS reveals which stocks have rewarded options buyers the most
Buying options is a whole different ballgame compared to buying stocks, in part because of the time value component of an option's price. Whereas a vanilla stock trader simply needs to be right on the direction of the stock's price, an options buyer needs that expected stock move to play out within a fixed period of time -- and that move needs to be substantial enough to offset the negative impact of time decay on the option's value.
Implied volatility (IV) is a key component of time value, and it reflects the market's expectations for how much volatility the stock will realize over the life span of the option. Internally, we use a metric called the Schaeffer's Volatility Scorecard (SVS) to help us identify stocks that regularly make bigger price moves than their options IV levels would suggest.
SVS works by measuring a stock's realized volatility against the volatility expectations priced into that stock's at-the-money options over the past year. As such, it helps identify which stocks historically have been the best -- and worst -- for premium buyers.
T he Schaeffer's Volatility Scorecard (SVS) is calculated by analyzing straddle returns over the past year (252 trading days). The straddle prices are calculated daily from hypothetical options that are exactly at-the-money and expire in exactly the holding period selected (one week or one month). We derive option prices using implied volatilities from actual options that closely match the hypothetical ones in terms of strike and expiration. The return data from these hypothetical straddles is then compared across all tickers, resulting in a score from 0 to 100. The top 20 stocks with a score of 99 or 100 are below.
Due to instances where options do not trade or bid/ask spreads are too wide, most stocks do not have returns for all 252 days. These 250 hypothetical straddle returns per stock for each year are used to calculate the SVS value, which considers three weighted criteria: 40% is based on the average straddle return; 40% is based on the percentage of positive returns; and 20% is based on the percentage rank of the straddle IVs. These metrics are then combined into a score ranging from zero to 100.
High SVS readings (up to 100) indicate that a stock has consistently delivered bigger returns than its options IV levels have predicted, meaning it may be a strong candidate for premium-buying strategies going forward, as well. Low SVS readings (all the way down to zero) point to stocks that have consistently realized lower volatility than their options have priced in -- pointing to possible premium-selling candidates.
It's important to remember, though, that the SVS is not necessarily predictive of future outcomes, given that it's a lagging indicator. Instead, we look at the SVS alongside coincident volatility indicators -- such as 30-day at-the-money IVs and the term structure as a whole -- and combine that analysis with our usual technical and sentiment-driven critiques to pinpoint the strongest possible stocks for option-buying opportunities.
To learn more about identifying options trades, check out this primer on implied volatility. To get ready for earnings season, be sure to read about this options strategy.