Article / 12 December 2016 at 14:44 GMT

Volatility Update: Energy stocks lead equities tear up — #SaxoStrats

Product Manager, Options Trader, Educator
  • 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

l 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.


Source: author

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
VIX Daily
 Source: SaxoTraderGO

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. 

Traders positions

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. 
SPY risk reversal
 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. 

Open interest

Source: QuikStrike

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. 

Crude oil

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'Rourke

Georgio Stoev is futures and options product manager at Saxo Bank
Market Predator Market Predator
Agree. Weeklies might be interesting product for binary event. Nice reading Georgio. Could you please help me to understand why in Saxo Platform, instrument VXc1 (cont. VIX Futures) is at 13.4 and in MT4 spot VIX spiked to 15.5? Some issue of: "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) " ?? ZQF7 (Federal Funds) in Saxotrader is also new world for me, I'm still learning :) Thx.
Market Predator Market Predator
Good morning Georgio. I slept well and better checked article above. Maybe my MT4 VIX is in fact VXV as you mentioned in the table, correct?
Georgio Stoev Georgio Stoev
thanks for reading and your thoughtful questions, MP. There's bunch of volatility indices- the most aclaimed one being VIX- the cash index measuring the 30-day volatility, VX is the futures on CFE exchange (ST is displaying as VXc1). The VXV, measures the volatility just like the VIX but the 3-month volatility is used to show how significant is the skew in implied volatility. Under "normal" conditions, VIX<VXV (IV is higher for longer date options as there's more uncertainty), but when VIX is greater than VXV, implied volatility higher than the future IV - we look for it to revert to its mean and comeback below. This reckons oversold market conditions...
Market Predator Market Predator
OK, seems to be clear now, appreciate your feedback! BTW, as this is in fact last sensible trading Wk I wish you great holiday, Christmas and wish you all the best in 2017, hope you will continue in Education. Thx. Georgio. Regards, MP :)
Georgio Stoev Georgio Stoev
anytime, happy holiday to you as well.


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