In the case of NOW stock, for the May 15 expiration date, put IV is relatively elevated at the boundaries. This setup reflects a net prioritization toward downside tail risk protection, as well as a synthetic short on the deep in-the-money (ITM) put side, potentially to protect actual long exposure to NOW.

To be fair, the elevation is controlled so there’s no panic hedging going on. But what’s really telling is the lack of upside convexity; traders are not showing much interest in speculating on a bullish spike. Potentially, this could mean that call options may be relatively cheap on a volatility basis.

Another microstructure to consider is gamma exposure. This statistic measures the change in delta exposure for options based on changes in the underlying price. Ultimately, this activity covers the continuous hedging dealers perform to keep their option books delta-neutral.

Interestingly, when looking at the May 15 expiration date for NOW stock, gamma flip occurs around $114.30, while gamma clustering hits a maximum peak between $125 and $135. Around the tail end of this range is possible, where technical resistance may show up, as the gamma positioning would require dealers to sell NOW to keep their books balanced.

If you are the speculating type, there’s a sizable window here to possibly exploit before the well runs dry.

Sizing Up the Trade

Before placing the trade, we can refer to the Expected Move calculator to make sure that our trading targets fall within the realm of rationality. Hinging largely on IV readings, the calculator estimates that for the May 15 expiration date, NOW stock should land between $103.97 and $144.71. So, in theory, we could potentially push our trade to nearly $145 and still be rational.

However, because the volatility skew revealed that the priority is not to position for upside convexity, call options should be relatively discounted. As it turns out, we can buy the 130/135 bull call spread expiring May 15 for a total net debit of $230 (which is the most that can be lost in the trade).

Should NOW stock rise through the $135 strike at expiration, the maximum profit would be $270, a respectable payout of over 117%. Also, the second-leg strike offers a 6.7% cushion to the upper dispersion of the Expected Move calculator, which helps enhance the trade’s probabilistic credibility.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com