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Low VIX Strategy & Skew Play (VIX, VXX, VXN, SPY) 10.19.2012

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From the prospective of an options trader, one should know the basic categories of being a net premium seller vs a net premium buyer. Each category clearly has is pros and cons, but it more or less could debatably come down to one’s volatility forecast. It is popular, for example, to fade the implied volatility pump pre-earnings; for uncertainty rules around catalysts. Then as the event comes and goes implied volatility collapses and traders cover their short premium. The former is very dependent on a good risk reward ratio, forecasted IV crush, and underlying asset…but it is all based around volatility.

The five-year (#Fibonacci) average of the VIX (252 trading days in a year x 5= 1260) over 1260 periods is around $26.00. This is roughly 60% from current levels, but it is important to remember that when the VIX decides to move, it really moves. The last time we were at a $26 VIX was in June 2012.

Large trades in the VIX seem to confirm this upside potential. Big players were trading the upside call skew in November, more specifically, the NOV 23/28 1×2 call spread. This is taking advantage of the upside bid in the VIX calls, for this trade takes in a small credit by selling the short strike of a long call spread 2x. It profits big in-between the strikes, but profits start to trail off after 28, should the VIX really explode by NOV VIX expiration.

Equity option strategies that would most likely profit from this kind of VIX scenario include the loved & hated gamma scalp. While Greeks are obviously important here, the concept is really simple. Long straddles fluctuate, benefiting from volatility, then as one side of the straddle profits, traders sell or buy stock to neutralize their deltas as the straddle becomes delta bias toward the winning side. As the stock moves up and down, small profits are made via scalps; offsetting time decay. The challenging part of this strategy is when to neutralize said delta along with scanning for a good underlying. Scanning for a stock with not too much IV, but with just enough bang is what most find challenging, for if volatility or the stock does not move, this strategy is crushed.

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Author

mark@keeneonthemarket.com

MarkVIX

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Unusual Options Activity 10.18.2012

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Paper bought 1995 NXY Nov 26-27 Call Spread for $.50 (2.6 times usual volume) when stock was trading $25.73

Paper sold 10,000 ALU Jan 1 Calls for $.25 (8.4 times usual volume) when stock was trading $1.13

Paper bought 10,000 MHP May 55 Calls for $4.20 (19.8 times usual volume) when stock was trading $55.58

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Don’t Google for Profits, Just Read This: Pregame GOOG Earnings From Every Angle (GOOG, GOOSY, SPY, QQQ) 10.18.2012

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The first graphic is a daily bar chart of price’s reaction to the past nine earnings announcements from GOOG. Action after the event is mixed; in most of the sample set, six of the nine observations, GOOG gapped and pinned on expiration (red vertical line). In the other observations, GOOG gapped, but then filled or reversed into said gap. This is indicative of efficient markets and random walk…for each observation is unique and independent of past price action. The gap is price’s way of adjusting to new news. While this gap may seem inefficient, the derivatives market, in most cases, was expecting said move.

Now to what is implied for the coming event, because the GOOG October options only have two days until expiration, they will be an organic way to derive what is implied for the event today after the close. Using the KOTM implied volatility & time based model, we calculated the one-sigma move (68% probability within) to be roughly $44.17 up/down or about 68% chance we settle between $799.67 and $711.31 by the close on Friday. The two sigma move (95% probability within) is $88.35 either way or $843.85 & $667.13. On Wednesday, October 17th 2012, the stock had a 1.5% pop while the market was only up 0.5%…1% alpha (we will touch on GOOSY alpha options later). The implied volatility curve (IV being a measure of risk, supply and demand, relative price, and an input into theoretical models) is displayed below, for it is important to know, especially if one is trading two different months in a spread.

The following chart includes the one and two sigma rolling probability cone, volume profile, and major moving averages (50, 100, 150, & 200). While the chart may seem noisy, it sure does tell us a lot if you listen! GOOG broke out of its June-July range on 7/5/12 and has yet to seriously look back. The recent pullback tested the trend line and 23.6% Fibonacci retracement level. Other than little support levels like prior lows, the next serious support level is the 50-day moving average at $710. On expiration Friday the 50-day will sit at the lower end of the two-sigma rolling probability level. The rolling probability levels and the KOTM probability levels differ for inputs like IV were not the same. The rolling used a lower IV, an average of the whole IV curve, which says there is a 2.5% chance we test the 50-day by expiration Friday (nearest red vertical line) vs the KOTM probability of 16% we test the 50-day by expiration Friday. The KOTM model is only used for the next two days, for it would not be appropriate to input 80% IV over the long term, as this one is only used before an earnings announcement. Additionally, we are currently sitting at the point of control on the upper, yet small, distribution. The other moving averages sit about 15% below us.

The ATM (at the money) front month $755 straddle (lifting the offer) is at about $39.50 (5.2% of stock). Because deltas move to one faster near expiration, it is easy to calculate break evens on the straddle; $715.75 & $794.25… IV crush, large gamma, and time decay. It is vital to note that given the ATM straddle, it is estimated that GOOG will need to expire one standard deviation away from where we are now, or move + or – $44, either way, just to make about 10% on the trade (using the KOTM sigma model).

IV is actually cheap however, historically speaking, given the average is 102% and Wednesday closed at 79%. The average % move and net change are about 7% & $40 respectively…see excel sheet for all data. Considering GOOG’s price, the ATM straddle will cost about $4,000. This is where the GOOSY will come in handy, while this is not a pure GOOG play, (see link below for alpha options explanation), it does lower the relative cost. The $88 ATM GOOSY straddle is about $4.10, about 4.6% of that product, and only $410 per one lot!

Alpha options explained here LINK

http://www.keeneonthemarket.com/blog/1562-goog-aapl-spy-alpha-option-review-avspy-a-goosy-10172012

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Author

salerno.mark.a@gmail.com

Data courtesy of Thinkorswim

 

MarkGoog3MarkGoog2 MarkGoog1

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GOOG & AAPL v SPY Alpha Options Review (AVSPY & GOOSY) 10.17.2012

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The index is simply a function of the absolute difference between the performance of AAPL and SPY. On 10/12/12/ the SPY closed down 0.34% while AAPL closed up 0.26%. So calculating the outperformance of AAPL would be adding SPY’s 0.34% to AAPL’s 0.26%, thus coming up with AVSPY’s close of up 0.60%. One could think of this product as long AAPL and short SPY, but not having to worry about weights, the proper amount of compensating shares, or borrowing costs.

Nearly any financial media outlet will have guests on touting this market as very unique, for it’s been a ‘stock pickers’ market…as if there is a market where you don’t have to pick the holdings in your portfolio. These managers try to beat market returns with their unique strategy and insight into companies.  They attempt to pick excellent management with positive industry trends for example. The unfortunate part of this is that after all the fees and headache, most funds have returns just like an index fund.  NASDAQ OMX alpha options are a convenient way to track and trade this performance, if one was really inclined to invest in management vs the S&P 500. This is just one way to view this product; another could just simply be hedging an individual long with a short index. This could especially be valuable, for the market has been known to trade on news from individual companies with large business scope and market clout… like GOOG & AAPL; both of which have alpha options.

The AVSPY also only has one implied volatility (IV) traders need to worry about, for if speculators wanted to play this otherwise in a pair trade, there would be two different contracts with different IV profiles. Considering AAPL earnings are only about seven trading days away, this product will be an interesting variable to look at when constructing a trade.

Screen shot 2012-10-13 at 1.45.35 PM

Feel free to e-mail any comments, feedback, suggestions, or general inquiries to…

mark@keeneonthemarket.com