- Volatility in equities is extremely low
- Further rike hikes in the US are not seen as likely for the time being
- Tech stocks are sought after, also via passive exchange-traded vehicles
- We have a look at how to trade given these circumstances
Netflix is set to report tonight after trading hours. So now we look
at a possible trade. Photo: Shutterstock
By Georgio Stoev
It's an excruciating time to be looking for volatility in the market. Tamed by the Fed's re-assessment of inflation, volatility in equities, as measured by the CBOE Volatility Index (VIX), hit rock bottom by closing at $9.51, off 16% for the week July 10-July 14.
Friday's soft US CPI gave the Fed something to think about. According to the CME FedWatch
tool, there is now a very low probability of rate hikes for the next two Fed meetings. But could the Fed raise interest rates to blanket the "irrational exuberance" in the stock market? Time will tell.
For now investors are expected to continue their bets on tech stocks as more money finds its way into passive exchange-traded vehicles like ETFs, ETPs and so forth. Here's how other assets finished the week.
With volatility at record low, what should investors do? As a reminder, volatility — particularly implied volatility — is one of the most important components that goes into options pricing models. The premium of an option is derived from the following five criteria: strike price, underlying price, time (to expiration), volatility and risk-free interest rate. The strike price and the expiration are well defined due to the standardisation of listed options. In contrast, the underlying price and volatility are not. The underlying can rise or fall during the life of an options contract. So does the implied volatility.
Certainties and uncertainties
When uncertainty (VIX) in the market increases, the options' premium does so, too. After all, options are used effectively to hedge market risks. This increase in implied volatility is known as "expansion". When fear dissipates, the opposite takes place, and the implied volatility contracts. Option contracts increase in value when the "vega" of that options increases. For more on volatility and the "Greeks," please check out our webinar "Trading with the Greeks"
Going long/ short volatility
With volatility coming off on major indices, such as the S&P 500 and the Nasdaq 100, it could make sense to pick up some volatility "vega" through options. The Nasdaq 100 has exhibited greater swings over the last month, giving opportunity for both bulls and bears. Its implied volatility relative to the IV of the S&P 500 has been higher. This is largely due to the top five names in the Nasdaq 100 (Apple, Microsoft, Amazon, Facebook and Google) accounting for more than 40% of the index.
Source: CBOE Options Institute
The premium, of course, has receded in the last week but it's still there. Investors looking for volatility exposure in tech have three great choices to turn to: CBOE NDX options, CME E-mini Nasdaq 100 Index futures options or use options on QQQs. We are going to look at two simple ways to get long volatility exposure using Nasdaq futures options (QNE).
A little bit for everyone
Underlying: E-mini Nasdaq 100 futures (NQU7)
Price as of 7/14 (5847)
Buy: +1 QNEN7 5900 Call @ 35.50 /Sell -1 QNEN7 5930 Call @ 23.50 for Net Debit of 12 ticks ($20 per tick) $240
Max Risk: $240
Max Reward: $360
For those still in technology stocks and looking for some protection going into earnings, a bear put spread could make sense:
Buy: +1 QNEN7 5700 Put @ 20.25 /Sell -1 QNEN7 5650 Put @ 14.50 for a Net Debit of 5.75 ticks or $115
Max Risk: $115
Max Reward: $885
Selling volatility into earnings
For looking to sell volatility into earnings, as expectations are built into the options premium, one could look at a number of strategies including short strangles, back ratio spreads and iron condors. Here's an example of selling an iron condor into earnings. Netflix reports tonight after hours.
There's an approximately $13 move built into the the July 21 ATM straddle for Netflix, that's just over 8% up or down from Friday's close of $161.12. Over the last six quarters, ATM straddles have moved down from a 15% expected move in Q3 2015 to just over 8% during last quarter. Implied volatility is relatively high at 44% (64% high and 21% low).
Source: Dynamic Trend/Saxo Bank
The trade example above could yield higher premium (return) if strike prices were closer to the ATM and we sold further expiration, such as July 28.
For those owning shares in the above, the strategy could be modified by a short strangle (selling call 175 call and selling put 145 at the same time). If at expiration shares are trading above the short call of 175, you'd need to deliver the shares at $175 keeping the whole premium. If the stock tumbles and you are assigned the short put, you'd need to purchase shares at $145.
Source: Dynamic Trend/Saxo Bank
Before employing any of the above strategies, take time to investigate each particular strategy and whether or not it fits your personal risk tolerance and financial circumstances. Be sure to visit some of the OptionsLab webinars.
Have a great summer.
— Edited by Clemens BomsdorfGeorgio Stoev is futures and options product manager at Saxo Bank