Macro Wrap – Short Premium Trades and SPX Vol

by Enis January 17, 2013 7:17 am • Commentary

In the past couple weeks, we’ve done more trades that involved selling short-term premium than usual on the site.  Though most of these trades were done around earnings events, I want to highlight the importance of macro-level volatility to these trade structures.

Normally, when a trader considers an earnings-related trade, the focus is on that particular name, its options structure, and potential risk/reward for the trade chosen.  However, the broader macro environment cannot be ignored.  For example, look at the chart of SPX 10 day historical volatility (white) vs. SPX 30 day implied volatility (red):


Screen Shot 2013-01-17 at 6.51.41 AM


Chart Courtesy of LiveVolPro

The 10 day realized volatility in the SPX index is at 6%, about as low as you’ll ever see it (the SPX index has closed within 2 points of 1471 for 5 straight days).  But 30 day implied volatility in the index is near 6 month (and multi-year) lows, around 12%.  So traders have low expectations for macro volatility at the moment.

Why should that matter for earnings trades on single names?  Even though single stock options might seem to be their own world, a portion of their option premium is always derived from the broader market’s volatility expectation.  So when SPX index volatility is high, single stock options premium tends to be more expensive, all else equal.  When SPX index volatility is low, single stock options premium tends to be cheaper, all else equal.

Therefore, if the SPX index implied volatility is near 5 year lows, then single stock option prices should be near 5 year lows, all else equal.  Yet, we’ve seen many cases in the past week of earnings where the single stock options are implying a move for earnings that’s in line with the past 4-8 quarters.  As I’ve just explained, in this low volatility regime, I would expect the implied move to be lower than usual.  Since it has not been, we’ve generally been sellers of those high short-term option premiums.

In short, single stock options traders should be aware of both the micro and macro inputs involved; otherwise, you’re driving with one eye closed.

Markets overnight:

  • Asia was relatively quiet, with the Shanghai and Taiwan down 1%, but most markets close to flat.  Thailand joined other developing countries in talking down its currency.
  • European markets have traded around flat, up 0.25% right now.  SPX futures are up 0.1%
  • BAC reported better than expected earnings, but revenue missed by 7%, and the stock is trading a touch lower.  PNC beat earnings and revenues and is indicated higher
  • BA is trading down $2 to $72.40 as the FAA grounded all U.S. 787 Dreamliner flights until further notice as it investigates the battery problems at Japan’s airlines.
  • Housing Starts, Building Permits, and Jobless Claims data at 8:30 am