12 September 2016 at 13:30 GMT
- Finally, volatility breaks out of its box
- Note that as expiry nears liquidity typically drys up
- Come join us for our regular Wednesday webinar
By Georgio Stoev
Things went a bit volcanic on Friday.... Pic: iStock
It's here, finally. Everyone feels relief now – the bulls for a reason to book profits and the bears to get a confidence boost. For weeks now we've been expecting the volatility to break out and return to its mean or at least back above its 200-day moving average. Now that this is a fact, what is one to do? Before we attempt to provide an answer, let's see how major asset classes performed last week:
Source: Saxo Bank
Past week in rear view
The CBOE fear index (VIX) was not the only contract trading in the black. Light Sweet (CLV6) also made a pop and by midweek the price leaped some 8% before giving up some of the gains. Nevertheless, it was a good bounce on increased volume. We suggested that traders could work with a October 45/47 call spread for entry price at $1. During Wednesday's trading session the call spread could be sold back at $1.35 or 35% ROR in two days. (Click here
to read last week's edition of Volatility Update – The deafening silence of the VIX.
We also suggested a trade using VIX futures and options in the form of a covered call. Naturally, the October futures (VXV6) had a huge gain on Friday and closed at $17.84 or up 9.3%. At the same time the VIX 19 October 16 20 calls are bidding $1.80, or a loss of .75 per contract. The net trade for this covered call results in a gain of $0.86 ((17.84- 16.23) - ($1.80-$1.05)) or $860. Your gain will be capped at $20 at expiration.
Finally, Facebook's protective put strategy is also working as designed. At the time of this writing shares are off another $1 in pre-market. It doesn't bother me one bit as I have 39 days to decide what to do with this core position of mine.
The week ahead
Let's look at our crystal ball for a minute: the moon is going through its waxing gibbous and it's supposed to light up in its full glory by the weekend. The last will take place before the fall equinox when the sun crosses the celestial equator from north to south. This might have the following impact on the markets:
If you are long volatility through options, i.e. call spread or with a single legged option, you should have a clear price target level in place. After the full moon, we expect volatility to normalise and be brought down into the low teens.
Friday's volatility was amplified by futures expiration. Most equity index futures are due to expire this week. As volatility expanded, market participants holding September E-minis needed to make some adjustments before the weekend. As expiration nears, liquidity in the contracts about to expire typically drys out. So investors may face difficulties getting filled with competitive prices. To avoid this, traders will close or roll existing positions ahead of time. On Friday, 58% of the E-mini futures volume was composed of December expiration. (Click here
for more detail on this.)
The process of rolling out of existing position is easily done through our calendar ticket on the SaxoGo.
Friday's gap down on heavy volume could suggest more pressure over the course of the weak for equities and bonds. The higher readings (above $16.72) in VIX should translate into higher premium for options and give option traders good risk/reward. Come joins us this Wednesday for our regular webinar and find out what option strategies we could use with volatility elevated. Click here to sign up – it's free!
Have a great week ahead!
– Edited by Clare MacCarthy
Georgio Stoev is futures and options product manager at Saxo Bank