- Energy stocks ride oil wave to help equities higher
- Fear index well below the 3-month volatility average
- Markets largely unconcerned by Wednesday's FOMC outcome
- There are a number of ways to play the meeting
Dow Jones Index is getting ever closer to 20,000. Photo: iStock
By Georgio Stoev
US equities, along with global equities, had tremendous lift last week. In addition to the red hot conglomerates sector, up 20% in a month, the rally was broad-based with technology in the mix. In fact, all nine sectors of the S&P 500 were up for the week.
The Dow index is now within hair of reaching 20,000, mainly due to shares of higher priced Goldman Sachs, IBM and less from General Electric.
Fear of low fear
At the same time the Chicago Board Options Exchange "fear" index (VIX) moved a tad lower and closed the week at $12.10, near a 52-week low. The index is now well below the 3-month volatility (VXV) of $15.22 and that is really bullish for stocks.
VIX below the 3-month volatility of $15.22
As the fear seems to have receeded, investors seemed not to be bothered one bit by the upcoming Federal Open Market Committee meeting. Moreover, the market has already implied a 95% probability of the Fed raising rates by at least 50 basis points. The probabilities are calculated based on the CME Fed Fund futures
( ZQF7 on Saxo Trader) . Anything less or more than half a percent could provide for some volatility going into the holiday season.
Trading the VIX cash index has traditionally favoured buying call options (traders expecting volatility to rise) and not so much puts, especially near a 52-week low. This past week was no exception, witness a put-to-call of 0.68. However, on Wednesday we had a sudden lift in the volume of VIX put options as some 260K put contracts traded, at par with calls. This could be attributed to a few big positions being rolled out ahead of expiration (VIX options expire on Wednesday)
The inexpensive gift
With volatility low, protection in the market place is relatively cheap. A protective put or a risk reversal could come out at about a 1% premium. For instance, a trader could extend to a 3% on the money short call and a 5% OTM protective put (collar) and pay just over 1% premium to hedge a position. The example illustrates the purchase of a 13 January'17 215 Put and the selling of a 13 January'17 233 call.
source: Options Dynamic
This neutral to bearish strategy could be constructed in various ways, i.e. distance from the market, expiration and so on, but the point is that insuring your profits for the year through a mechanism like a flexible collar could be the best gift you receive this year.
Going into Wednesday
Weekly options are a great way to participate in a binary event such as earnings, nonfarm payrolls
or the Fed announcement. Because of the shorter time, weeklies are less expensive than the standard expirations. You also don't need to buy more time than necessary. The best of all is that a tiny movement in the underlying could have a big impacts. The CME Globex lists
a deep pool of liquid options for market participants such as the E-mini Weekly Options. In addition to the Friday expiration, in September the exchange listed Wednesday's expiration which have gained popularity among traders due to their European-style expiration and multiple listings.
Target in mind
If you had a price level in mind, you could approach the event in many different ways. Just ask yourself two basic questions: what price level and what timeframe? For, if you expected a move of let's say an additional 1.3% gain or loss in the S&P 500 by year-end, you could work with a double diagonal using the E-minis options.
In a DD, you'd benefit from a price movement as well as time decay and volatility. Buying end-of-the-month calls 2280 against Week 4 2280 should result in a net debit (as of this time $3.25). Adding another calendar this time on the put side, EOM 2230 puts and Week 4 2230 puts can be made for roughly $3.75. All together that is $7 per contract or about $350 per one contract ($50 multiplier). The volatility is very low right now so this strategy has a potential if the underlying moves, either up or down.
The black swan
Accumulation of puts in the E-minis have been on the rise. The increased demand rises the premium in all options. Nevertheless shorting the E-minis is also an option.
For instance, a trader could sell a Week4 OTM 2280/2285 call spread for $1.10 and use the proceeds to buy a long put on the standard December 16 expiration.
Following Opec's cuts in production, oil volatility has snapped and it's back down in the low $30s/b (VXO). The losses in Opec is favouring the US oil industry. Add the cold weather front in the US and the 6-month old breakout in crude oil (CL) and we could very well be at $60/barrel before Christmas.
As always, be careful as the fear seems to have disappeared and put on some hedges and enjoy the holiday season.
Have a great week ahead!
Oil could head towards $60/b before year end. Photo: iStock
— Edited by Martin O'RourkeGeorgio Stoev is futures and options product manager at Saxo Bank