Since breaking out above 1900 to new all time highs on May 27th, the SPX has grinded higher by about 2.5% or about 50 points and now sits up 5.5% on the year, up 12% from the 2014 lows made in February. Despite all the consternation about a needed correction for most of the year, volatility has been smooshed with the VIX trading at levels not seen since 2006 (see our discussion from early today of the VIX here). The 8 year chart of the SPX vs the VIX shows the inverse relationship of the two, with the obvious conclusion that something is likely to give, and soon:
This morning (here) I laid out the following thoughts as to my view on U.S. equities at current levels:
Just because it could go up another 3, 5, or whatever % doesn’t mean it is a great spot to commit new capital to equities. It is my view that the risk/reward of capturing the next 3-5% to the upside does not outweigh the potential for a quick 10% decline (which we have now not had for the longest stretch since 1996). It’s coming, but from where? 1950, 1975, 2000?? I have no clue. I will continue to short stories that don’t make a lot of sense for a whole host of reasons (CRM, WYNN), and look for opportunities to play from the long side in large cap laggards to re-test prior 52 week highs where I see slightly limited downside (relative to crowded trades) in a 10% broad market correction (CSCO, F, GE, VZ).
For those who think we continue to grind higher and are not in favor of trying to pick a top, or shorting a dull market, playing for some high quality laggards to re-test prior highs with defined risk could be the way to play given just how cheap options prices are.
GE is a name that sticks out to me. It’s kind of cheap, trades at a market multiple but has lagged the SPX massively this year, still down 3.25% in 2014, but up 11.5% off of the February lows. The price action in the stock today is notable breaking out of the two month range:
The mini-breakout has been backed up by some fairly interesting options activity with total volume more than 2x average daily volume, with 80% of the activity in calls, with July 28th most active with 8k trading.
Volatility: Implied volatility is dirt cheap and the options themselves are dollar cheap. If GE were to bust out to new highs it’s possible that could trigger some option buying increasing implied vol as the stock goes up. Additionally, the July expiration captures earnings and IV should ramp up into the event. Here’s a 5 year chart showing just how low IV is currently
July implied vol is under 15 and is likely to be near 20 going into the earnings event, which gives a lot of room for error on buying a dollar cheap option to play for a breakout.
I would also add that some industrial peers like JOY and NAV reported better than expected results this week, with JOY breaking out to new 52 week highs, up 11% in the last 2 trading days alone:
Could GE be the next industrial to re-take the prior highs and more if they report better than expected Q2 results and guidance on the morning of July 18th options expiration? I am willing to risk .16 that it will. Why? Because options prices are basically screaming to be owned. The July 28 call which captures any and all price movement for the next 40 days and the earnings event, cost less than 1% of the underlying stock price for a 3.5% break-even on the upside for a stock that is down 3.25% on the year:
Trade: GE ($27.12) Bought to open the July 28 calls for .16
Break-evens on July expiration:
Profits: unlimited above 28.16
Losses: up to .16 btwn 28 and 28.16, with max loss of .16 below 28
Trade Rationale: This is a dollar cheap option to play for new highs in GE. The combination of a potential breakout and earnings could keep the option bid and counteract any decay that would come from a boring market.
One last thing, this 8 year chart of GE must have some technicians salivating and could lend itself over the next few weeks of rolling to a longer dated bullish trade, but for now I like the risk reward of playing the earnings event with cheap vol and low premium.
