I discussed the Brazilian elections in this morning’s Notable Options Activity post:
1. EWZ – The Brazilian elections are on Sunday, and investors have gotten pessimistic on the market as polls have shifted in favor of President Rousseff (see this Reuters article for more details). EWZ neared its March (and 5 year) low of $38 yesterday:
However, calls were much more active than puts yesterday, trading about 3x more in volume (vs. the 1 month average ratio of 1.4 to 1). The Oct31st 48 calls traded over 30k at an average price of $0.476, and the Dec 52 / 54 call spread traded 27k for 0.13.
EWZ is up 5% today after four straight days of losses, though it is still down on the week:
The ETF is still down more than 20% from the early September high, a steep descent even for a volatile market like Brazil.
We were discussing whether the news of Rousseff’s election on Sunday, which is widely expected, might turn out to be a “Buy the News” type of event. In other words, traders have been selling in anticipation, but with the election finally out of the way next week, the aggressive sellers might be finished with the market near the lows.
Granted, the fundamental situation for Brazil is not exactly favorable, with China slowing, commodity prices in decline, and the domestic economy still in the doldrums since the first half of the year. Nevertheless, the market’s decline reflects those poor conditions, along with the likely election results. I might be interested in a trade if the options market offered a good risk/reward opportunity to play for a bounce over the next couple of months.
However, when I perused the options market for trades, the high level of implied volatility is a significant impediment to long premium structures near term:[caption id="attachment_47255" align="alignnone" width="600"] 30 day implied volatility in EWZ, courtesy of Bloomberg[/caption]
30 day implied volatility is at its highest level outside of late 2008 / early 2009. That makes calls and call spreads especially expensive. For example, the Feb 45 / 50 call spread costs $1.20, which has a break-even of $46.20. That is up about 10% from EWZ’s current level, which is a tall hurdle just to break even in an index ETF.
However, the near term vol spike hasn’t dragged up some of the out months’ IV as much as you would think. Some of the calendar opportunities seem nuts. The best trades seem to be selling the super high vol in the Oct31st weeklies and buying either Feb or MArch options. Here’s the one we put on:
(NOTE: Option markets are wide, so be sure to use a limit order.)
TRADE: EWZ ($41.75) Buy the Oct31st / Mar 46 call calendar for $0.59
-Sell 1 Oct31st 46 call at $1.27
-Buy 1 Mar 46 call for $1.86
Break-even on Oct31st expiration: Losses with large moves below or above $46 with max gains at $46. Ideally the Oct31st calls expire worthless with EWZ near $46, and the Mar calls can then be traded on their own for a very low initial cost
Rationale: Since the cost of the calendar is so much lower, than the cost of the outright Mar 46 call, the break-even range is much wider than a usual calendar. This trade is probably profitable as long as EWZ remains between $39.50 and $52 by next week’s close. We structure the trade slightly bullishly given the decline in the past 2 months. Even outside of that range, it’s not likely a big loss until another few dollars. Moreover, there are still 5 months until March expiration, so there is still significant time value in those options after a big move either way. We like those odds, and will revisit the trade next week after Sunday’s elections.