SpaceX Options May Not Follow the Standard IPO Playbook

SpaceX options launched last Tuesday and have had some interesting volatility developments since then. As I wrote two weeks ago (SpaceX Options), options on new and much-anticipated IPOs tend to reflect the uncertainty of the underlying and are priced accordingly. Triple digit implied volatility results but soon fades as a price range is established and uncertainty decreases. Vol crush ensues.

Robinhood’s IPO is a great example. Options on HOOD began trading on 08/04/2021 at 215.1%; just 10 trading days later, it was down to 102.1%, a full 113.0 percentage points lower. Rivian’s post-IPO implied volatility followed a similar trajectory, opening at 179.6% and then falling to 100.1% 10 trading days later.

SpaceX options behaved more or less according to plan. On day one of options trading, implied volatility (30-day) was trading at 111.6%. After the initial rally in the underlying failed, SPCX IV fell to 86.2%, 25.4 percentage points lower. As of Monday’s close, it stood at 91.4%. Coupled with time decay, that represents quite a tax on traders who bought options early on.

However, and unlike most other IPOs, I suspect that SPCX implied volatility will remain elevated for two reasons:

1) The stock has very limited float. Float is the freely tradable portion of a company’s stock, excluding restricted shares held by insiders during lock-up periods. At just 4%, the SpaceX float is extremely low. Limited supply and strong demand can amplify volatility and make the stock more sensitive to large orders and news reports. As a result, SPCX implied volatility may be stickier to the downside than was the case with other IPOs that had higher float.

2) Daily SPCX price swings are not moderating, and the company’s valuation is still in flux. After spiking 19.4% on its first trading day, on June 22 SPCX declined 16.4% to $154.60, 23.4% lower than it’s close at its peak last Tuesday. As long as daily double-digit returns prevail, implied volatility should relatively high.

Consequently, uncertainty is still rightfully high and SPCX options should remain relatively expensive until the situation changes. Of course, SpaceX has been trading for barely more than a week, so prices may consolidate as it fades from the news and establishes a trading range. In that case, SPCX implied volatility should gradually decline.

Trading Games

A grim joke on Wall Street goes something like this: a genie grants a trader one wish. Of course, the trader asks for tomorrow’s newspaper with every stock, bond, and commodity closing price, high and low, volume, etc. The genie then grants the wish and conjures up the newspaper. After spending the rest of the day and night researching tomorrow’s price action on his way to certain fame and fortune, the trader places all his orders. When he’s done, he decides to take a look at the rest of the paper. Unfortunately, along with tomorrow’s prices, he also notices his obituary. Twilight Zone anyone?

I thought of this when I read about Elm Wealth’s Crystal Ball Challenge, described below:

“Two years ago, we put that conjecture to the test. We called it “The Crystal Ball Challenge.” We staked 120 finance-trained adults with $50 each and handed them the front page of the Wall Street Journal – one day before publication, with any mention of market moves blacked out. In effect, we gave them what every trader dreams of: a working crystal ball. They could go long or short the S&P 500 and 30-year Treasury bonds, with leverage if desired. For example, shown Wednesday’s front page – reporting on Tuesday’s events – they placed their trades at Monday’s close and were closed out at Tuesday’s close, once the news had played out in the market. Each player got 15 trading opportunities, one front page per year from 2008 to 2022.”

The results were interesting. On average, the paid players broke even and about 1/6th went bust. 60,000 additional players staked with $1 million in play money did even worse.

Why? First, First, markets do not always react to news as expected. Unfortunately, the market isn’t always logical or consistent. Prices may already reflect the news, investors may focus on a different detail, or the market may simply ignore it. Second, since the traders believed that they had an insurmountable edge, the players used excessive leverage and poorly sized their trades. Since they picked the correct direction only about 50% of the time, their returns suffered, often disastrously. In short, they erroneously thought they had an edge and bet too big.

When AI models were instructed to trade like a typical wealthy middle-aged US investor, they did better in picking direction and ended up with higher nominal returns. But when the models were put up against professional investors, the results were more of a dead heat. On a nominal basis, the models won, but on a risk-adjusted basis, they came in second due to excessive leverage. Apparently, the professional investors knew better how to size and lever their trades in relation to their convictions.

Of course, the only real test would be against traders using real money and in real world conditions. Traders behave differently when their financial well-being or livelihoods are on the line. Regardless, the game’s broader lesson is clear: successful trading depends not only on how well you interpret the news but on how well you size and manage your trades. The latter is often mistakenly overlooked or paid less attention, with dire results.