The Federal Reserve's decision to leave rates unchanged sparked a two-day rally in equities as one would expect. Supporters of the efficient market theory could argue that all known information is already priced into equities, but where does this leave us? Before we provide some insight on the options market for the week ahead, let's see how different assets performed last week...
Looking back over last week, risk appetite returned in all assets except energy and volatility products – even European equities turned up for the week. We do like the overall strength in the emerging markets ETF but will wait for a break above $38.32 before moving in.
Gold has long been a good asset to have in your portfolio but it has been frustrating to trade over the last two months. Taking the directional bias out for now, we suggested a short put spread strategy with the GCZ6 future.
Bonds – the asset that is most sensitive to changes in interest rates – rallied for the better part of the week. In long paper, the 30-year bond (ZB) looks to have established strong support near 164'17 and we could expect further gains.
Traders' options positions are showing a lot of interest with 164 put options on the underlying futures (ZBZ6) with November expiration.
According to Chicago-based futures broker R.J. O'Brien, traders are starting to prepare higher
yields in the bond market, especially if the Republicans win the November presidential elections in the US. The latter could suggest that the accumulation of put options for both hedge and speculation could continue.
And as for volatility?
While equity indices are moving higher, the volatility in the market has moved lower. The demand for out-of-the-money put options, particularly for October and November, seems to have abated over the last week as the skew has shifted downward.
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Source: Saxo Bank
Traders are now looking at 2,100 as a key level for the E-minis S&P 500 futures (ESZ6).The week finished with some traders taking positions in end-of-the-month E-minis. The positions were initiated mostly on the long side with 1,900 – which is deep, deep out-of-the money – being most active.
For the week overall, traders initiated positions in the 2,100 puts and the at-the-money 2,150 calls. We initiated a market neutral strategy involving the EOM E-minis as the time decay on these options is rapidly melting away.
New listing by the CME Group
The world's largest derivatives exchange is extending further opportunities to traders with its listing of the "Wednesday Weeklys". These options will be listed every Wednesday
and will provide traders with an additional tool to create market views around economic announcements such as those from the US Bureau of Labor Statistics (nonfarm payrolls), the Fed, and more.
(Saxo Bank will look into listing these options as well.)
The week ahead
As the market's attention is now on the November elections, we see opportunities in the market very selectively within equities and prefer tackling these through either exchange-traded products or through the equity index options (E-minis, SPX).
For those maintaining a larger exposure in equities (and hopefully gains), it's time to take a look at options from a more strategic angle in which they are employed as a protective tool. With volatility fairly muted, the premium for protection is also fairly low.
For example, a 2,100 November put option in the E-minis (ESZ6) with 53 days to expiration will cost you $1487.50. For a concentrated portfolio of $100,000, this is a premium of 1.5% to insure these savings and lock in your gains.
In addition to the above protective strategy, investors should look to utilise covered calls which in combination with protective puts (collars) could play out very nicely in the weeks and months to follow.
— Edited by Georgio Stoev