Trade Update – $EWZ: Sold Call Calendar For Profit

by Enis October 29, 2014 11:03 am • Commentary

EWZ has rallied back to where it closed on Friday ahead of the elections, suggesting that market participants were not that surprised by Rousseff’s election victory.  That was our expectation when we initiated the Oct31st / Mar 46 call calendar on Friday, in addition to the very favorable risk/reward of calendar spreads heading into the event.

At this point, the trade is essentially a long Mar 46 call, since the Oct31st 46 call has lost most of its value.  The original intention of the trade was more based on our volatility view (that farther dated options were priced too cheaply relative to weekly options).  The remaining position is more of a directional view on EWZ, which we don’t really hold.  Given our neutral view, and the fact that the volatility trade has played out, we’re going to take our gain on the EWZ calendar.

 

ACTION:  EWZ ($41.90) Sold to close the Oct31st / Mar 46 call calendar at $0.91 for a $0.32 profit

 

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Considering Our Options – $EWZ: Brazil Waxed

The Brazilian election results are out, and Rousseff won as expected.  While the decline in EWZ today of 7% seems severe, the ETF has actually held above its 52 week low of $38 this morning.

We put on a call calendar on Friday, mainly because the vol differential between the weekly options and the March options offered a very good risk/reward opportunity.  Well, with EWZ down 7%, our call calendar is trading around flat from Friday, a good illustration of the advantage of trading such a steep vol term structure.

Here is what we wrote with regards to EWZ in Friday’s post:

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.

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.

With that in mind, we still think the odds favor a bounce in EWZ in the coming week.  Yesterday’s election result were no surprise for anyone following Brazil closely, so today’s large decline could be capitulation by the few remaining hopeful investors.

Our short weekly 46 call position is essentially worthless.  Against that, our long March 46 call is probably worth between $0.45 and $0.75 (market is very wide).  We considered selling an upside call in Dec or Jan15, but those are not going to fetch more than 0.25.  As a result, we’ll simply hold on to the March 46 call for now, with the plan to get out on the first significant rally in EWZ.  While the end result is not a big winner, the odds of this trade structure were still significantly in our favor at initiation on Friday.

 

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New Trade – $EWZ Calendars: Brazil Nuts!

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:

EWZ daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

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:

EWZ weekly chart, courtesy of Bloomberg
EWZ weekly chart, courtesy of Bloomberg

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:

30 day implied volatility in EWZ, courtesy of Bloomberg
30 day implied volatility in EWZ, courtesy of Bloomberg

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.