When I write about option volatility for individual stocks ahead of earnings, I often compare it to insurance. If you live near the ocean in Florida/South Carolina/North Carolina, which is prime hurricane territory, your insurance is expensive because of the potential damage. And because of this potential, insurance companies price insurance expensively to protect themselves.
Similarly, because earnings or drug announcements can be huge/binary events, are great unknowns and can cause a big stock move, the prices of options go higher ahead of earnings because market makers don’t want to sell cheap options ahead of a big move.
So what happens to insurance and reinsurance stocks such as HCI Group (HCI), Everest (RE), Assurant (AIZ), XL Group (XL) and Universal Insurance (UVE) when a real hurricane, such as Irma, is approaching?
I’ll focus on HCI Group, though every stock listed above looks the same.
HCI Group is an insurance holding company that operates through four operating divisions: property and casualty insurance, reinsurance, investment real estate and information technology. Through its subsidiary, Homeowners Choice Property & Casualty Insurance Company, the company provides property and casualty insurance to homeowners, condominium owners and tenants on properties located in Florida. HCPCI also offers flood-endorsed and wind-only policies to new and pre-existing Florida customers.
Essentially, HCI was at huge risk as Irma headed towards Florida. And you can see in the stock chart, traders were selling the stock aggressively in recent days, sending it from 40 to a low of 28 on Friday.
And as the hurricane approached, traders were buying insurance/puts on the insurance companies. This hurricane was a huge event for these companies (similar to earnings). Here is the graph of HCI option volatility:
However, now that the hurricane has passed, and initial estimates are that the losses are on the lower end of the expected range, the stock is bouncing back by $5.20 today.
And with the hurricane past, options prices are falling dramatically. Here is that same volatility graph, but now with today’s big drop in prices:
The hurricane has passed and—like after an earnings announcement—traders no longer need to own as much protection and prices plummet.